Friday, August 24, 2007

Asian Bond Fund 2, Exchange Traded Fund and Market Reform

Asian Bond Fund 2 (ABF2) has been launched by the Executives’ Meeting of East-Asia and Pacific Central Banks (EMEAP) on May 2005. ABF 2 with total fund of USD 2 billion is divided into two funds, PAIF with USD 1 billion and country sub-funds with USD 1 billion. This fund will invest in domestic currency sovereign and quasi-sovereign bonds in eight EMEAP economies: Indonesia, Hong Kong, China, Singapore, South Korea, Malaysia, the Philippines, and Thailand.

ABF PAIF as an open-ended listed bond fund is the new asset class in Asia and also the first exchange-traded fund (ETF) issued by Asian financial institution. ETF as a hybrid security is aimed to track the index performance. It is similar with mutual fund but it is not considered as mutual funds. As it is traded like a stock, it provides low transaction cost, allowing investor to buy at minimum one share and having diversified product in one unit.

ABF is intended to foster the development of domestic and regional bond market by enhancing the demand side of bond market and encouraging the supply side to issue more bonds. However as ABF will only invest in local currency sovereign and quasi-sovereign bond, there is a big question whether the ABF’s role will give a significant impact to the supply side.

The fact is ABF has been designed with strict policy in selecting bond thus it will only select high grade bond as its portfolio. In Asian markets, even few years after the 1997 financial crisis up to present, the demand for high grade bond remain strong. This left us with a somehow contradictory impression about the demand supply mechanism of high-grade bond. If the demand side is strong, what are the factors that cause the supply side not to give a strong positive response?

In case of Indonesia, I think there are two major constraints that cause low growth of high-grade bond, first is lack of benchmark yield curve and low liquidity and second is poor informational, legal and regulatory system. The first one imply to bond pricing and the second one imply to the risk which arguably it may cause one bond (eventually) gets lower rate (compares to the real/factual performance) and fall below the category of high grade bond.

On my view, the implementation of ABF has to be parallel with the market and regulatory reform. Obviously, ABF will create wider range of instrument for investors and help the domestic market to solve its liquidity and benchmark yield curve problems. The ABF ETF is expected to be the major step in the structure product and derivative investment in ASEAN markets. It is the local government’s challenge to make sure ABF ETF will get the right path and give the best impact to the development of bond market, locally and regionally.

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