Aug. 21–That the Bank of Thailand has received applications to invest US$2.5 billion in foreign-currency debt instruments is not surprising. The policy, to actually permit this, is a step in theright direction. The overwhelming response is a function of the current situation.

There are surplus funds to be invested by Thai individuals, institutions and corporates. And the return on lower-risk assets (i.e. fixed-income securities) has fallen significantly in the past few years. The Thai government 10-year bond is yielding less than 3 percent (after dropping to a low of 2.4 percent earlier this year).

Compare that to the 10-year US Treasury bond yielding 4.5 percent and investing overseas starts to get interesting.

However, there are things to consider for both investors as well as the central bank. For investors, the structure allows an institution to invest either directly or via a fund structure. Hardly any local institutions possess the in-house expertise to manage offshore bonds directly. And for those who wish to do it, I would suggest it is an activity that has to be monitored constantly, especially given the current interest rate environment.

The US Federal Reserve has made it very clear that there is no reason to consider a change in their interest rate policy stance. The market seems to have gotten ahead of itself in terms of assuming a rate increase. While the US economy is doing well (third-quarter growth may be up as much as 5 percent), there is no sign of any inflation and importantly, this seems to be growth without any real job creation.

Keep an eye on job numbers as they effect a reaction from interest rate policymakers.

But, while the central banking authorities are clear, volatility in the overseas fixed-income market has increased. The easy money has been made. Investors need to exercise some prudence when committing funds and they should be ready for short-term swings in either direction. Of course, the volatility will also bring the benefit of being able to trade the markets more effectively.

So, for the institution investing in funds directly, I would suggest it constructs a portfolio with a trading element — that’s where things will be for the time being. Otherwise, durations should generally be shorter.

For institutions that wish to invest via funds — the safer thing to do in my opinion given limited expertise — I would not focus much on recent past performance. The good times in the fixed-income market are ending. I would rather focus on the fund manager’s ability to manage risk in volatile market conditions. There are some very experienced offshore fund managers to consider.

So forget past returns — focus on risk management. Also focus on the structure of the fund — the duration, the currency exposure. Each investor will have different requirements and targets. So, my advice can only be general in this column.

For the Bank of Thailand, this is an excellent first step. However, the allowance to invest overseas should be expanded beyond fixed-income securities in due course.

Apart from allowing investments in equities, investing in alternative assets (i.e., private equity funds, mezzanine funds and hedge funds) should also be considered. Hedge funds are theoretically the best protectors of capital in volatile markets. Hedge funds also deploy a variety of trading and arbitrage strategies (depending on the type of hedge funds) to diversify risk.

Forget the reputation derived by hedge funds in the crisis years as currency speculators. Barely a handful (if that) of the thousands of hedge funds worldwide speculate in exotic currencies nowadays.

Hedge funds have also become very popular. In the second quarter of this year alone, investors around the world poured close to $14 billion into hedge funds. Why? Superior returns, incentive-driven structures and most important, the ability to manage risk in uncertain market environments.

But I have run ahead of myself here. For now, investors should take advantage of the excellent policy move and diversify their portfolios and enhance their returns through offshore fixed-income securities.

The author can be reached at: nibsri@hotmail.com

—–

To see more of the Bangkok Post, or to subscribe to the newspaper, go to http://www.bangkokpost.com

(c) 2003, Bangkok Post, Thailand. Distributed by Knight Ridder/Tribune Business News.