Foreign investors have a thing for Korean bonds

Foreign investors are scooping up Korean bonds while retreating from its stocks.

The foreign buying spree for local bonds is fueled by higher yields driven by the country’s base interest rate of 1.25 percent, which recovered to its pre-pandemic level before the United States announced its rate hike, and instability in the European market.

In February, foreign investors net sold domestic stocks worth 2.6 trillion won ($2.1 billion), while net purchasing bonds worth 6.4 trillion won, according to the Financial Supervisory Service.

Of the 6.4 trillion-won in bonds purchased by foreigners in February, 2.5 trillion won matured in the same month, meaning that net investments from abroad amounted to some 4 trillion won in February.

Bond purchases by foreign investors have seen a steady increase since last year.

The total amount of listed bonds in Korea owned by foreigners reached a fresh high for the 14th straight month of 221.9 trillion won in February, up 46 percent from January 2021.

Foreigners owned 9.7 percent of bonds listed in Korea as of February, a 2.4 percentage point increase from January 2021.

Bond investments are considered undesirable when the base interest rate is facing an increase. However, foreigners actively bought Korean bonds despite anticipated rate hikes because of perceived long-term stability based on the country’s fiscal soundness.

Moody’s and S&P Global Ratings have given AA ratings, the third-highest investment grade, to Korea. Hong Kong and Taiwan have sovereign credit ratings of AA- by Moody’s, one tier below Korea’s AA. The credit ratings of China and Japan stood at A+, two tiers behind Korea.

Yields on 10-year government bonds closed at 2.856 percent on Thursday, the highest since October 2014 and much bigger than Japan's 0.23 percent, or Taiwan’s 0.8 to 0.9 percent.

The yield on benchmark U.S. 10-year government bond closed at 2.295 percent on the same day, some 0.5 basis point lower than Korea's.

Yields were boosted by the interest hike by the Bank of Korea, which took place before the U.S. Federal Reserve raised its base rate to 0.5 percent on March 17.

Foreign exchange profit is another factor.

“In bond investments, the profit and cost made from foreign exchange hedges are considered along with the interest rate differential,” said Meritz Securities analyst Yoon Yeo-sam.

Yoon explained that “even when the gap between the interest rates in the United States and Korea closes, the profit from the forward exchange may increase.”

Russia’s invasion of Ukraine also lifted demand for Korean bonds.

In February, net investments in government bonds from the European region amounted to 1.8 trillion won, claiming the largest share.

The Asian region followed with 1.3 trillion won, with the Middle East investing 600 billion won and North America 400 billion won.

“Government bonds accounted for 77 percent of last month’s net purchases of bonds, and that seems to be from global bond investment funds,” said an insider in the financial service industry, explaining that “the inflow of European capital was fueled by the precarious geopolitical situation in the region.”

Long-term investments in government bonds by foreign investors are on the rise as well.

Net investments in bonds with a remaining maturity of less than a year decreased by 332 billion won in February compared to the previous month, while bonds with a remaining maturity of more than a year and less than 5 years increased by 2.3 trillion won.

Net investments on longer-maturity bonds, with more than a 5-year term, also climbed by 2.0 trillion won on month.

However, analysts said that bond investments might not be for everyone.

“If the gap between the U.S. and Korea’s base interest rates closes, the preference for Korean bonds will eventually die down,” said KB Asset Management analyst Jung Sang-woo.

For retail investors, Jung said, “It would be more realistic to put money in an installment savings plan with higher interest rates than to make a 10-year investment in bonds.”

BY LEE TAE-YUN [shin.hanee@joongang.co.kr]