FTSE Russell review on MGS sparks market concerns


In early April, the Norwegian sovereign wealth fund (SWF) announced it will trim its exposure to emerging-market (EM) bonds as part of an effort to overhaul its fixed-income holdings.

Malaysia is among the EM countries witnessing a sell-down in its government securities (MGS) with market participants’ total expected disposal close to RM8 billion.

The index service provider, FTSE Russell, announced it might drop Malaysian government debt from the FTSE World Government Bond Index due to concerns of market liquidity.

Although the review will be released in September this year, market participants are already pricing in the expected outflow of another RM8 billion.

Within the local unit trust industry, local bond funds had shrugged off the Norwegian SWF announcement as bond fund performance continues to trend higher despite the news.

FTSE Russell’s plan to review its exposure of MGS has sparked concerns among market participants, which buoyed MGS yields upwards and sent a ripple across the domestic bond market.

The impact on each bond fund differs by the underlying exposure. Funds that have higher holdings of MGS have witnessed a greater magnitude of correction compared to those that have lesser exposure.

In our view, a decrease in foreign holdings tend to lead to lower local bond funds performance.

Going forward, we believe the downward pressure on bond prices will persist in the near term as market participants may not fully priced-in the event.

The initial market reaction was from investors offloading their active or tactical positioning in the MGS space.

For foreign investors to assess their position in MGS, they have to look at the fundamentals of the Malaysian economy and determine if the yields offered by MGS is attractive enough to compensate for their risk exposure.

Our take is that the disposal of holdings by Norwegian SWF or an index exclusion does not materially affect the fundamentals nor the economic health of Malaysia. The accessibility and liquidity concerns within EM bonds like Malaysia are a known fact to many market participants and investment experts.

Hence, foreign investors may decide to hold onto their position as the coupons generated by the MGS holdings could help them cushion losses from short-term price correction.

Foreign index fund managers may find little incentive to roll over their MGS positions in the future if MGS is dropped from the FTSE World Government Bond Index, but some active fund managers may take position away from benchmark to generate alpha.

Based on historical data, the Malaysian bond market is resilient against negative surprise events.

While short-term losses may occur, the bond coupons collection over time can help investors recoup short-term losses and the recovery trend may also be assisted by buying activities from local market participants when a sell-off is deemed overdone.

In the event of a sharp correction, we believe investors should hold onto their bond fund holdings and ride out the correction period.

The above two events are more prominent to foreign investors who have or are looking to add positions in MGS.

As for local bond fund investors, while we foresee an increase in volatility within the local bond space in months ahead, this asset class will remain relevant to investors for diversification benefits.

If there is any further sell-off, we believe that offers an attractive opportunity for investors to buy on the dip.

Existing investors who are looking at paper losses should continue to hold onto their position for reasons stated above.