Goldman's Bullish on Korea Debt But Investors Unsure on Time

  • Military drills could make Korean bonds volatile: PineBridge
  • Fidelity prefers Chinese investment-grade debt, Asian issuers

Goldman Sachs Group Inc. said this month that South Korean global corporate bonds are cheap and offer value, in spite of simmering military tensions between the U.S. and North Korea. Some investors aren’t sure the time is right to buy.

The average yield premium on Korean dollar bonds has risen 20 basis points this year to the highest since March 2016, compared with a four basis-point increase for Chinese debt, JPMorgan Chase & Co. indexes show. Meanwhile, Korea’s sovereign-debt risk rose above China’s for the first time since May 2013, according to CMA data. Such market moves are still not enough to entice some investors from Hong Kong to Frankfurt to consider getting back into Korea debt quite yet.

The nation’s bonds could be volatile in the near term as the U.S. and South Korea hold annual military drills, risking a return to the war of words between President Donald Trump and North Korean leader Kim Jong Un, according to PineBridge Investments. While some in the market consider the widening in Korean debt spreads a buying opportunity, better credit investment alternatives exist in Chinese investment-grade corporate bonds and quality issuers from Southeast Asian countries such as Indonesia and India, according to Fidelity International.

“I don’t think it is a time to move decisively overweight yet, although I believe we would accumulate assets slowly” in Korean debt, said Arthur Lau, head of Asia ex-Japan fixed income in Hong Kong at PineBridge Investments. Geopolitical tensions are “likely to drag on much longer this time,” he said.

North Korea warned on Tuesday that the U.S. will face “merciless revenge” for ignoring its warnings over annual military drills with South Korea, setting a more belligerent tone after rhetorical spats appeared to have subsided in recent days. The drills and visits of U.S. military officials to South Korea create the circumstances for a “mock war” on the peninsula, the state-run Korean Central News Agency said.

Goldman Sachs said that the rising tensions may lead to more volatility in risky assets, especially if the rhetoric escalates. But it sees Korea’s geopolitical risks as “more tail events than modal events,” and that the nation’s credit products still offer value. South Korea’s investment-grade bond spreads and sovereign credit-default swaps have widened since tensions began rising around October last year, while spreads in other Asian countries tightened, analysts including Kenneth Ho, its head of Asia credit research, wrote in a note dated Aug. 11.

Union Investment Privatfonds GmbH figures that over the medium term, dollar- and won-denominated Korean debt is “one of the most attractive places to invest,” according to Christian Wildmann, a Frankfurt-based senior portfolio manager. However, Union is “still careful in adding exposure” in Korean debt due to political uncertainty, said Wildmann, whose firm manages about 304 billion euros ($359 billion).

In affirming South Korea’s AA rating with a stable outlook last week, S&P Global Ratings cited the nation’s steady economic growth, its high degree of fiscal and monetary flexibility, and a solid external position. Although geopolitical tensions have risen in the Korean peninsula, a direct armed conflict is unlikely, S&P said.

See also: military tensions are hurting Lotte Shopping in China

Still, the market isn’t shrugging off the military tensions. It’s hard to predict how they will be resolved, and investors seem to have become more cautious toward Korean bonds, according to Clement Chong, senior credit analyst in Singapore at NN Investment Partners, which oversees about $280 billion. This may affect demand for primary issuance in the near term, he said.

Hyundai Motor Co.’s financing arm Hyundai Capital Services Inc. sold $600 million of five-year notes at a 135 basis-point premium and $300 million of 10-year bonds at a 155 basis-point spread this week. In February, the company issued 2022 notes at a spread of 125 basis points, 10 basis points less than the similar-maturity debt this month.

Offshore bond sales by Korean companies have increased 26 percent this year to $22.5 billion, Bloomberg-compiled data show. Other borrowers in the pipeline to sell dollar notes include Kia Motors Corp., Lotte Shopping Business Management (Hong Kong) Ltd. and Hanjin International Corp., according to people familiar with the matter.

“We are taking the current situation seriously while at the same time acknowledging the recurring nature of those tensions,” said Bryan Collins, fixed income portfolio manager at Fidelity International in Hong Kong. A further widening in credit spreads is “currently considered a buying opportunity although our appetite is constrained by what we consider overall as stretched valuations in the South Korean space,” he said.

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