A reader of my recent article on dim sum bonds, which was reposted on Seeking Alpha, expressed confusion about what action we recommend. While we are not, per se, making recommendations, here’s a clarification of what I meant.
We believe that longer-term, the dim sum bond market will be viable and provide opportunities for investors to capture attractive risk-adjusted returns. At the moment, however, this market is too expensive, because of supply and demand imbalances that favour bond issuers, not investors.
Our research also suggests that the renminbi will appreciate over the medium term by around 5% per year. Longer term, we estimate that it is 20% to 25% undervalued. We believe that investors could take advantage of the potential appreciation of the currency.
As a result, we favor investing in other Asian bonds now, and overlaying these positions with a currency hedge to gain exposure to renminbi. This would provide exposure both to potential appreciation in the renmimbi and a diverse pool of government and corporate bonds offering yields around 4% to 4.5% and potential capital gains. In contrast, dim sum bonds now yield around 2% to 3% and pose the risk of mark-to-market capital losses as supply increases to meet demand.