Share good articles on private investors' over-the-counter investment in bonds

Share good articles on private investors' over-the-counter investment in bonds

~ The net purchase of over-the-counter bonds by individual investors, which averaged only 260 billion won per month for 10 years from 2012 to 2021, exploded about 13 times to an average of 3.3 trillion won per month for two years from the second half of 2022 to the first half of 2024. The background of the surge in demand for bond investment by individual investors is the demand for holding maturities on high-interest bonds, the demand for capital gains, and the demand for tax savings. In particular, if you look at the list of bonds held the most by individual investors, the preference for "low-coupon bonds," which are ultra-long-term and have low surface interest rates, is remarkable.

As a result, there was an abnormality in that interest rates of non-representatives were lower than those of active trading targets as low-coupon bonds, which were issued at low interest rates in 2019-2021, were unusually premium. In the near future, if investors' thoughts are focused on "the Fed's cut in the benchmark interest rate is being completed or fully reflected," there is a high risk of problems with the exit strategy to realize profits by selling bonds. Individual bond investors who have purchased low-coupon bonds and are aiming at capital gains will be safe to realize profits before the perception spreads that expectations for a cut in the benchmark interest rate will be completed, or when it is judged that it is difficult to actually cut beyond the cut in the benchmark interest rate currently reflected in the bond market.

~ Third, it is a demand for tax savings. Taxation on bond investment is levied on coupons (surface interest rates). Bonds with low surface interest rates issued in the first half of 2019-2020, when the bond rate was near the lowest point, are in high demand from large asset owners for tax savings. For example, in the case of 20-year KTBs (19-6) issued in September 2019, the maturity rate is 2.95% as of August 27, 2024, but the surface rate is only 1.125%, so the deposit conversion rate compared to the bank's deposit rate is about 3.70%. For large assets with a tax rate higher than the general tax rate of 15.4%, the deposit conversion rate of return is higher. National Housing Class 1 bonds (five-year maturity), which are compound government bonds with a low surface interest rate of 1.00%, are also popular as bonds for tax savings.

In fact, if you look at the list of bonds held the most by individual investors as of August 27, 2024, the preference for "low-coupon bonds" with low surface interest rates stands out. Taking the example of "National Treasury 01500-5003 (20-2), which individual investors hold KRW 4,393.6 billion, the largest single stock, the first number is the surface interest rate, and the second number is the maturity of the bonds. In other words, it shows "the treasury bonds with a surface interest rate of 1.50% and a maturity of March 2050." "20-2" means that it is the second treasury bond issued in 2020. It can be seen that low-coupon bonds, which are mostly 1% surface interest rates issued between 2019 and 2021, are preferred, including the 1.50% surface interest rate of the national treasury 20-2, which is the largest holding. In the second largest holding, "19-6," nearly 30% of the bond issuance balance is held by individual investors. This is an extremely unusual situation. For reference, individual investors held KRW 54.0 trillion as of the end of July 2024, accounting for 2.5% of the total bond issuance balance.

The interest rates of indicators and non-indicators are reversed in the government bond market

The explosive enthusiasm for individual bond investment is also affecting the portfolios of institutional investors. This is because individual investments are mainly focused on demand for capital gains from falling interest rates by buying low-coupon long-term government bonds. This is the result of predictions that the Fed's rate cut will be possible at least in 2024, as the Fed's rate hike has been completed along with the possibility of an economic recession. As a result, an abnormal phenomenon is observed in which the interest rates of indicators and non-indicators in the government bond market are reversed.

In Korea, one 20-year KTBs are issued a year, and two 30-year KTBs are issued a year. The most recently issued KTBs are called 'indicators', and the KTBs issued before that become 'non-indicators'. Whenever new bonds are issued, long-term bonds are accumulated one after another in the accounts of institutional investors who hold bonds such as insurance companies and pension funds until maturity. Over time, the indicator becomes a non-indicators, and the volume of non-indicators decreases. Therefore, recently issued indicators, which are the most active and liquid in trading, are generally more expensive than non-indicators (low interest rates). Indicators are mainly in high demand from securities companies, asset management companies, and banks that generate profits through active trading or exchange trading.

Low-coupon bonds, which were issued at low interest rates in 2019-2021, had shorter maturities than indicators, higher interest rates (cheap), and excellent tax savings effects, so it was natural for individuals seeking maturity retention and tax savings to seek them. However, in 2023, individual investors' demand for capital gains was concentrated on non-dispersed objects with excellent tax savings effects, and as non-dispersed objects were unusually premiumed, interest rates on non-dispersed objects were lower than those on active trading indicators.

Risk of problems with selling strategies when the perception of 'the closing phase of expectations for interest rate cuts' spreads

Since it is relatively difficult to obtain bonds due to the small trading volume of non-representatives, they have to buy bonds at an interest rate that is about 0.20%p lower than the indicator. Unlike the stock market, the bond market has a high proportion of over-the-counter transactions. The characteristic of the over-the-counter market is that when the buying advantage is the real estate market, the sale disappears, and when the selling advantage is the case, only the asking price tends to rise sharply. This is especially true for non-representatives (low coupon bonds), which have an absolute proportion of over-the-counter transactions. There is no problem when investors disagree, but there is a very high risk of problems with the exit strategy to realize profits by selling bonds in the near future if they are focused on the idea that "the Fed's base rate cut is nearing an end."

This means that there is a high risk of being sold only when selling at a much lower price than the visible price at that point. This is the same reason that when there are many sales, such as the real estate market, which is an over-the-counter market, it must be sold at a lower price than the market price. It is a risk that low-coupon bond investors must face at least once. There is a widespread perception that individual bond investors who have purchased low-coupon bonds and are aiming at capital gains will complete their expectations for a cut in the base rate