IN the persisting low-yield environment, institutional investors that are no longer able to rely on investing in safe assets to meet their liabilities have taken on more risk and turned to higher yielding investments in the hunt for yield. In this environment, would Belt Road project bonds – project bonds with China’s implied or explicit backing under the Belt Road initiative – be a compelling investment?

According to Asset Benchmark Research (ABR), investors were split (51% in favour) over whether they would be interested in investing in Belt Road project bonds.

Project financing is the financing of long-term infrastructure projects based on a non-recourse or limited recourse structure, in which the proceeds used to finance the project are paid back from the cash flow generated by the project, rather than from other assets of the borrower.

Project financing can be in the form of bank loans, private placements or traditional project bonds. Project sponsors typically choose to tap the capital markets – as opposed to bank loans– for larger projects, or for projects where they can match long-term liabilities to the project’s commercial format and contract. After the Basel III regulations, project bonds enable sponsors to lower the cost of finance given that the tenors for these bonds are often longer than what is available in the bank loan market.

The return of Asian project bonds was marked in late 2017 when Paiton Energy tapped the capital markets with the largest-rated amortizing international bond for an infrastructure project in Asia since 2000. Although this latest issuance may be a sign of things to come, in Asia project financing is still primarily conducted via bank loans or funding from governments or multilateral institutions, according to a Moody’s report from early 2016. Debt capital markets financing is limited in the region except for in China, South Korea and Malaysia, according to Moody’s.

The Asian Development Bank says that the region needs to plug a US$1.7 trillion infrastructure investment gap in transport, power, telecommunications, and water and sanitation annually from now until 2030 to maintain its growth momentum. This capital requirement dwarfs the combined funding capacity of multilateral institutions, banks and governments, as such the capital markets could play a key role in plugging the infrastructure investment gap. Institutional investor participation in project bonds via the debt capital markets would help to provide an additional source of liquidity for infrastructure projects in Asia, either by funding greenfield projects directly or by offering refinancing options for projects after construction.

The Moody’s report also suggests that institutional investors could be interested in increasing their portfolio allocation to infrastructure as it offers the ability to match long-dated liabilities with long-term investments backed by infrastructure assets. It also allows for portfolio diversification as well as attractive risk-adjusted yields. Given the current low-yield environment, Asian pension funds in particular will have to invest more in alternative assets such as infrastructure in order to meet their long-term liabilities and generate returns.

But while investment in project bonds might be on the brink of a renaissance, what about project bonds supporting Belt Road projects?

While there have been fundraisings in support of Belt Road projects – for instance China Construction Bank issued a one-billion-yuan (approx. US$160 million) Belt Road infrastructure bond in August 2015 – there has yet to be a specific Belt Road project bond. When ABR asked fund managers if they would be interested, the responses were lukewarm.

For some, their interest would turn on the bankability of the project, given Belt Road projects could have long construction times and are often in political or economically unstable countries. “Only if the projects are sound fundamentally,” says a Singapore-based investment manager.

Another managing director also based in Singapore is concerned with country and currency risk: “[It] depends on the host country for these projects and the outlook for the currency,” he says.

According to one Taiwan-based fund manager, the risk is too high. “The risk involved in project bonds supporting the Belt Road is high, and according to group policy we prefer not to be exposed to high risk investments,” he explains.

For some, the Belt Road aspect is a meaningless addition used by Chinese corporates to signal that they are following the national policy, making it no more special than a normal bond: “I never care about this category because every Chinese corporate that comes out says they are doing something related to the Belt Road initiative. So, to be honest, I find it a bit meaningless,” says a portfolio manager based in Hong Kong.

For others, the Belt Road label brings the likelihood of government support and credit enhancement: “The Belt Road projects will undoubtedly gain either explicit or implicit support from governments,” says a fund manager in Malaysia. “This will enhance the credit strength of these projects and provides assurance to investors alike. New issue premium will be and looks attractive to investors, and the liquidity of these project bonds will improve as more market players can participate,” he says.

Malaysian respondents were the largest group interested in Belt Road project bonds, perhaps due to their greater familiarity with this type of structure. “It allows for diversification away from local infra/project bonds,” says a head of investment based in Kuala Lumpur.

Some Asian investors are also attracted to project bonds in order to meet local regulatory requirements. “Investing in project bonds supporting Belt Road will be included within Indonesia Regulatory (POJK) requirement of minimum 20-30% investment in local sovereign bonds and or infrastructure bonds,” says a senior portfolio manager based in Jakarta.

These data are part of ABR’s ongoing Asian Local Currency Bond Benchmark Review 2018. To participate, please click here.

Methodology
The Asian Local Currency Bond Benchmark Review is conducted in the first quarter of the year. Over 300 local currency bond investors including asset managers, hedge funds, private banks, insurance funds and commercial banks from 11 Asian markets namely China, CNH, Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan and Thailand take part.

Data sets include market penetration, market share/wallet share, buying criteria/client satisfaction, research content and the top individuals. To learn more about the Asian Local Currency Bond Benchmark Review please click here.