High-rise apartment buildings at China Evergrande Group’s under-construction Riverside Palace development in Taicang, Jiangsu province, China, on Friday, Sept. 24, 2021.
Qilai Shen | Bloomberg | Getty Images
Asian high-yield bonds have been a hot favorite among institutional investors for the last few years.
Also known as junk bonds, they are non-investment grade debt securities that carry bigger default risks — and therefore, higher interest rates to compensate for them.
One recent high-profile example was the debt crisis at China’s Evergrande. Weighed under more than $300 billion of liabilities, the world’s most indebted property developer is teetering on the brink of collapse. Fears of a broader contagion to the industry, and perhaps even the economy, triggered a global sell-off in September.
Given the uncertainty of China’s junk bond market, CNBC asked five strategists and portfolio managers: Would you advise investors to buy Asia high-yield bonds?
To be clear, China real estate bonds form the bulk of Asia’s junk bonds. As Evergrande’s debt crisis unraveled, other Chinese real estate developers also started showing signs of strain – some missed interest payments, while others defaulted on their debt altogether.
Here are the responses from 5 strategists CNBC interviewed:
1. Martin Hennecke, St. James’s Place
Head of Asia investment advisory and communications
Investors should “avoid the use of leverage of any bonds or bond funds at this point in time,” Hennecke strongly recommends, referring to the practice of borrowing money to invest.
He said that predictability of returns in high yield bonds “isn’t nearly as clear-cut … and such a strategy can turn out to be much higher risk than anticipated.”
“The recent sharp sell-off in Asian high yields, coupled with the likely default or restructuring of some, is a good example of this,” he told CNBC.
Hennecke also said investors should diversify globally in order to manage sector and country risks.
“Last but not least, investors should be well advised to diversify across asset classes as well, noting that fixed interest as an asset class generally is vulnerable not only to default risk, but also interest rate and inflation risks,” he said. Rising price pressures are “arguably on the rise and in my view possibly still underestimated today,” he added.
But that doesn’t mean investors should completely brush off high-yield bonds.
“All that being said, Asian junk bonds have already sold off sharply, sending yields much higher, and as long as one is conscious of the risk taken, I would suggest that the asset class shouldn’t be excluded from well diversified portfolios.”
2. Wai Mei Leong, Eastspring Investments
Portfolio manager for fixed income
“With China accounting for 50% of Asia’s high-yield bond market, the developments surrounding the Chinese property sector are likely to weigh on investor sentiment in the near term, but we believe that opportunities exist for the discerning investor,” Leong said.
While China’s property sector has historically been subject to episodes of policy-driven volatility, she said, “we recognize that the depth and scale of policy measures have been unprecedented this time.”
Still, the real estate sector remains an important driver of China’s economy, and accounted for 27.3% of the country’s fixed asset investment in 2020, while being a key revenue source for many local governments, Leong said.
“The Chinese government would therefore prefer to have a healthy property sector than to see multiple large-scale defaults, which could potentially trigger widespread systemic risks.”
Leong added that in the long run, China’s growing middle class, together with urbanization and the development of its megacities, will likely continue to support revenues of the property sector.
“Investors are likely to reassess their risk expectations towards the Chinese high-yield property bond sector in the near term,” Leong added.
But China’s drive to reduce debt within the property sector will ultimately result in “stronger market discipline” among real estate firms, and improve the quality of their bonds, she added.
3. Arthur Lau, PineBridge Investments
Co-head of emerging markets fixed income and head of Asia ex-Japan fixed income
Expect more defaults from the property sector in the near future, Lau said.
Still, he said he doesn’t expect defaults in specific companies to result in a systematic crisis.
He also said there will likely be policy easing on Beijing’s part — such as faster approval of mortgage applications and reopening of onshore bond market to stronger and better quality property developers.
All that should help ease some liquidity concerns, Lau added.
He also pointed out that selective property developers are still able to continue raising funds through the equity market, such as rights offerings and share placements, as well as asset sales.
The stronger developers will emerge from this crisis “even stronger” while the weaker companies may eventually default, Lau said.
“Hence, we cannot emphasise more the importance of careful credit selection to pick the winners and avoid the losers,” he said, adding that his firm expects “a very decent return in the coming six to 12 months if investors are able to identify the survivors and able to stomach the volatility.”
4. Sandra Chow, CreditSights
Co-head of Asia-Pacific research
“In general, we would stick to the more conservative credits in China,” Chow said, citing firms that have less debt or have strong government links.
“High yield credits in Indonesia and India have been more resilient and better supported by investors seeking diversification outside China or Chinese real estate,” she said.
“We wouldn’t avoid high yield altogether but individual credit selection is very important,” she concluded.
5. Carol Lye, Brandywine Global (investment manager under Franklin Templeton)
Associate portfolio manager
Chinese real estate firms issuing high-yield bonds have been sold off since August, particularly the lower quality bonds — but they later rallied, thanks to verbal interventions from Chinese authorities, Lye said.
However, Chinese real estate bonds had another selloff last week in what the portfolio manager said were “by far the worst.”
“This was driven by concern over hidden debt and contagion among higher quality [BB-rated] names which led to a fire sale across all names. Quality names were trading below 80 cents.”
B or BB-rated names are considered low credit quality rated bonds, and are commonly referred to as junk bonds. However, BB-rated bonds are of slightly higher quality than B-rated bonds.
News over possible changes in the three red line waiver for mergers and acquisitions “helped the market to stage a whipsaw rally especially in quality names,” she said referring to China’s “three red lines” policy which was rolled out last year. That policy places a limit on debt in relation to a firm’s cash flows, assets and capital levels.
Other encouraging signs for investors included a potential change in the reopening of issuance in the onshore interbank market, and a jump in October’s mortgage loans.
“This type of volatile wild market phenomena is not often seen and opens up opportunities to be positioned in quality names,” she said. “But caution is still warranted with volatility likely to remain as various property companies are still in a tight liquidity position.”