Mordy: DSUM Bucks Bond Trend

November 19, 2013

Fund focused on bonds issued outside of China is up while most global bond markets stumble.

This article is part of a regular series of thought-leadership pieces from some of the more-influential ETF strategists in the money management industry. Today’s article features Tyler Mordy, president and co-chief investment strategist of Toronto-based Hahn Investment Stewards.

Hollywood built a baseball diamond in a remote Iowa cornfield as a set for Phil Robinson’s 1989 drama, “Field of Dreams.” It remains there to this day, attracting more than 50,000 visitors each year.

A similarly obscure construction is developing in the financial world. This time, the venue is not Dubuque County, Iowa, but rather, China’s offshore bond market. This other building project will lead us to an already-existing ETF, the PowerShares Chinese Yuan Dim Sum Bond fund (DSUM | C), which cultivates a different field of dreams in the Middle Kingdom.

That said, some scene-setting will be helpful.

Consider that China’s economy is only half the size of the United States, and it’s the world’s largest export nation. Yet the majority of China’s trade flows are transacted in dollars (China’s currency, the yuan, ranks only eighth in world trade).¹ In fact, most emerging-market trade finance is invoiced in dollars (USD).

This paradigm presents a problem for China and its trade partners. During periods when dollar funding tightens, crises can easily erupt. The late-1990s Asian crisis is history’s most notable example (when unsustainable debts were amassed in foreign currency and liquidity faded).

But even as recently as this past summer, when the Bernanke Fed started “talking taper,” emerging markets—especially ones with large current account deficits—fell dramatically.

Clearly, the above currency system is not ideal. This is becoming more apparent as China increasingly integrates its supply chains with the rest of Asia and moves toward “near-sourcing” commodities and other tradable goods. Bilateral trade is soaring between China and the Southeast Asian bloc, reaching a new high of $400.9 billion in 2012, up 10.2 percent from 2011.²

An Expanded Bond Menu

As the wider emerging markets industrialize and move toward a more stable macroeconomic regime, a retreat from dollar dependence will be necessary. The obvious alternative is the yuan or, as It’s referred to more formally, the renminbi (RMB).

China, above all, knows this. That is why internationalizing the RMB has become such a politically pressing issue. But how will this be accomplished? If a happy story is to unfold, then the plot must include two key protagonists: a stable currency and reliable bond market.

Enter “dim sum” bonds. These are sovereign and corporate bonds issued outside of China but denominated in RMB. Western multinationals, like Ford, Volkswagen and Caterpillar, have tapped the market to raise capital.

Why would issuers do this? In short, to match revenues and liabilities, thereby hedging their foreign exchange risk.


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