GCC bond market expected to witness continued increase in the volume of issuances.
· Increased demand from international investors due to relative stability and appealing spreads.
· Performance of GCC corporate bonds remain subdued compared to High Growth Markets around the world.
· Oil prices recovery, structural reforms and better credit ratings should result in a positive re-rating of the region and trigger more spread tightening.
The Gulf Cooperation Council (GCC) region’s bond market, which saw record sales in the first half of 2016, is expected to continue experiencing an increase in the volume of issuances; as per an analyst note from Indosuez Wealth Management. The note observed that KSA and Kuwait inaugural bonds issuance are expected to generate significant interest from a broad range of international investors, similar to what was experienced with recently issued bonds from Abu Dhabi and Qatar.
Indosuez Wealth Management added that in the current environment of lower interest rates, the hunt for higher yields and longer bond duration is driving the demand for USD bonds higher. This situation is making bonds in ‘High Growth Markets’ a top performing asset class, with a growth of 11.5% on a year-to-date basis. With the ‘Emerging Markets Bonds Compendium’ at a 12-month high, this rally is being further lifted in recent times by the positive sentiment from US economic data and the recovery of oil prices.
Christiane Nasr, Director & Senior Investment Advisor, Indosuez Wealth Management, commented:
“Despite the strong year-to-date performance, more spread compression in ‘High Growth Markets’ could be still achievable by the end of 2016 without ruling out a degree of volatility along the way. In this overall context, the GCC region will increasingly gain more momentum as an attractive and more secure bond market for international institutional investors.
Attraction towards GCC bonds will become even more compelling due to general spread compression and market conditions elsewhere, with a large proportion of Eurozone bonds currently trading at negative rates, Asian bonds being stable but with tight spreads and Latin America continuing to be highly volatile despite yielding high returns.”
Technical aspects should remain supportive with the upcoming GCC bond supply expected to be well absorbed by a broad range of international investors, with notable large-scale sovereign debt issuance by Saudi Arabia and Kuwait, along with corporate/quasi-sovereign/GRE debt issuance by Oman Oil, Saudi Electricity, Investment Corporation of Dubai and Ooredoo. This is expected to be the case despite the GCC’s corporate bond market tightening by only 4bps YTD, making it the lowest amongst its peers in High Growth Markets.; with Latin America, Emerging Europe and the Asian bond markets tightening by 163bps, 100bps and 51bps respectively.
Christiane Nasr continued: “The large supply of GCC sovereign and quasi-sovereign bonds have provided investors with a stable option during this high-risk period caused by liquidity shortfalls perpetuated by the prolonged period of low oil prices. For this reason, bond issuances in the region were able to attract a large number of international investors at the end of Q2 2016.
However, while we believe that GCC bonds should remain resilient, we do not expect a significant outperformance of major corporates or sovereign/quasi-sovereign bonds where new issuance’ premium will likely re-price the relatively tight spreads among the outstanding local bonds. Our preferred investment area consists of GCC corporates that have remained fairly resilient despite the challenging macro outlook. Several corporates in the GCC region’s corporate bond market in the BBB rating category are offering an attractive spread close to 200bps, which translates into an 80bps pick-up versus US High Grade peers.”
Indosuez Wealth Management observed that the importance of an active investment strategy is even more crucial today, in a context where negative yields are primarily driven by demand from passive and benchmark-oriented players. Investors should resist the trend of chasing higher yields and should not fall in the trap of going outside their comfort zone, by going down the rating spectrum and adding meaningful risk to their portfolios.
Christiane Nasr concluded: “In context of the GCC bond market, we would opt for an active monitoring strategy of the new issues expected to flood the primary market until the end of the year. Accordingly, we could then carefully select ‘High Growth Markets’ and GCC bonds based on a bottom-up and a top-down approach as well. Furthermore, we would not hesitate to put limits on the Initial Price Thoughts of new issues during the book building process on the primary market to avoid being left without a new issue concession.
“With the stabilisation of oil prices over the past quarter, GCC bonds should witness better performance as long as crude prices do not fall significantly below current levels. As the GCC countries gradually begin to implement structural reforms, it will bring about wide ranging economic benefits which would ultimately result in better credit ratings and possibly translate into tighter spreads for investors in the future.”
