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April 2020

JKC Asia Bond Performance

In April, the fund (USD unhedged share class) generated a total return of +1.07%. This compares to a return of +1.80% for the benchmark IBXX ADBI Index (Far East closing prices) over the same period, giving a net underperformance of -73bps. In terms of breakdown of the fund’s +1.07bps NAV performance for the month, +72bps came from price movements, +28ps came from interest carry,+18bps came from exposure to the JKC 2023 fund, and -11bps from management and other fees, giving a gross total return (excluding fees) of +1.18% and a gross relative underperformance vs the benchmark  of -62bps. It should be noted that bond pricing mismatches at the end of March had a large impact on relative performance in April. Indeed, taking March and April numbers combined, the portfolio outperformed the Index by 18bps net (or 42bps on a gross basis) over this two month period. As of the end of April, the portfolio AUM (combined across all share classes) stood at USD56.3m, unchanged from USD56.4m at the end March, as positive gains in the bond prices was offset by a 1.4% decline in the EUR vs the USD during the month. 

Market sentiment improved last month as alarm over the rising death toll of the COVID-19 virus, and concerns of a sharp economic downturn following widespread national lockdowns across the planet, was offset by massive fiscal and monetary stimulus programs unleashed by most of the world’s governments and central banks. The resulting liquidity injection saw a shift to a more risk-on stance in equities with global indices recovering a significant portion of their March losses. Credit markets in the US and Europe also stabilized as anticipation of corporate bond buying programs by the FED and ECB underpinned  confidence  in the market and indices ended the month in positive territory, in part supported UST yields  remaining at multi-year lows. In Asia we also saw a modest rebound in both IG and HY bonds although the region lagged the rest of the world with yield premiums for Asian IG and HY bonds all trading at multi year highs by month end.

Asia’s underperformance in the April rebound is particularly curious given the region, led  by China, appears to be ahead of  the curve in both controlling the  virus and reopening the economy. On April 8th Chinese officials eased travel restrictions in Wuhan, the epicenter of the virus, and notwithstanding some sporadic small outbreaks in other provinces, infection rates  appear to have stabilized across the country. Similarly for other North Asian economies such as Korea, Taiwan and Hong Kong, case growth remains  relatively low demonstrating a  high level of success in containing the virus through targeted social distancing and contact tracing without resorting to full national lockdowns. South Asia had admittedly experienced some higher levels of infection during April although significantly lower than other parts of the world with most countries planning a phased reopening of their  economies in May.

Nevertheless Asian credit performance lagged developed markets as a combination of general risk caution towards EM debt, concerns over commodity price volatility after spot oil prices dramatically fell into negative territory mid-month, and the lack of bazooka style monetary stimulus programs in the region kept foreign investors on the sidelines.  Towards the end of the month, concerns of rising tensions between China and the US also surfaced as White House officials somewhat predictably started reaching for a political scapegoat for the virus likely with one eye on the upcoming presidential election in November. Although we believe a renewed ratcheting up of the trade tensions between the two superpowers is inevitable, it is unlikely we will see any major trade policies in the near term while the economic fallout from the virus remains such a severe overhang.

Within Asia we saw  a  modest outperformance of  HY names over IG bonds although the recovery was  highly sector specific in HY.  Indeed Chinese  property names, which tend to be mostly held by local investors, significantly outperformed more foreign held HY sectors such as India  and  Indonesia. In contrast, IG performance trends were less well defined with outperformers simply the names most beaten down in March, diving strong outperformance of Philippines sovereign bonds, gaming bonds and certain energy sector plays. Meanwhile multiple rating downgrades of the Sri Lanka sovereign saw that name significantly underperform other frontier issuers. 

One of the key features of the market in March was poor liquidity which led to both a material widening of bond price bid/offer spreads and a severe dislocation of bond pricing sources. Although in April this did improve for IG issues, pricing mismatches in HY bonds remained significant. As a consequence measuring relative performance of the portfolio vs the index remained extremely challenging, explaining the 62bps relative underperformance in April (which follows 97bps outperformance in March). We expect the pricing  mismatches  will average out over the long  term and in this  regard are encouraged by our ytd portfolio net outperformance of 6bps (or 49bps outperformance on a gross basis). We believe our defensive portfolio positioning going into 2020 including an overweight of Singapore, Korea and cash, an underweight of Sri Lanka, India and HY and neutral duration stance, were likely the key drivers of this ytd outperformance.

We ended April with an average portfolio yield of 4.00% (vs 4.21% a month ago and vs 4.07% for the ADBI) and an average portfolio duration of 4.80 (vs 4.77 a month ago and vs 5.17 for the index). Portfolio cash at the end of April stood at 8.7% (compared with 10.6% at the end of March).

Outlook

With the highly encouraging indications that COVID-19 case growth appears to have peaked in many developed countries in recent weeks, we are likely to see increased pressure for governments to begin reopening their locked down economies in May. During this critical phase, the key focus for markets will naturally be whether this leads to any resurgence in cases necessitating a re-imposition of restrictions.  While the breadth of testing clearly varies from country to country, currently available  statistics indicates only a  small fraction of the global population has yet been exposed  to the virus suggesting we are likely still far from a herd immunity scenario in any country. Meanwhile,  although headlines of virus treatment or vaccine development have driven some short term rallies in the market, most health experts agree we are still at least 12-18 months before any vaccine could be deployed on a widespread basis. Consequently although the return-to-work drive should be a positive near term catalyst for the market, we doubt the ‘COVID overhang’ will be removed completely and elevated market volatility will likely remain for the rest of the year.

In the meantime, the massive economic impact of the virus already felt from lockdowns cannot be understated. With a staggering 30m workers in the US filing for initial jobless claims in the past 6 weeks the US unemployment rate, which had fallen to a 50 year low at the start of the year, has likely swung to its highest level ever in April. Most of these jobs will be likely be recovered later in the year, but not all as corporates downsize their activities in the face of a virus driven economic slowdown. With similar negative labour market impacts being seen across the global economy and consensus estimates of a  1.5% contraction in the world GDP in 2020 we believe the April market rebound has not, in our view fully, reflected the state of the real economy. Indeed with the 22x forward P/E of the S&P Index trading at its highest level since 2001, we  believe the potential for further market corrections remain very high.

Global credit markets would potentially see some insulation from a valuation led correction given large central banks stated intention to underwrite bond markets however in a  recessionary environment  default rates will still likely rise, putting pressure on leveraged companies and dampen sentiment for EM. In March and April the three global rating  agencies S&P, Moodys and Fitch announced a total 325 rating downgrades  in the Asian market (compared to a typical average of ~30/month). Although rating agencies tend to be lagging indicators for the market, this does still reflect the  expectations  that default rates could pick up this year. Fortunately for Asia this risk is very much priced in. As of the end of April, the yield premium of Asian bonds compared to similarly rated US issues (even taking into account the rash of downgrades  in Asia), was at its highest level since 2011 ranging from 200bps for ‘AA’ rated  bonds to over 900bps for ‘B‘ rated issues. Asia’s cheapness provides a  powerful buffer against further market volatility.

Nevertheless, in terms of our JKC Asia bond portfolio we maintain a defensive positioning being overweight cash and maintaining a short duration bias in HY bonds where volatility should be less pronounced.  One major uncertainty from the COVID crisis and related massive stimulus is whether it will ultimately be inflationary or deflationary for the economy. This will likely depend on how easily central banks are able to reign in their QE activities once growth rates normalize again. Given this uncertainty we have raised our portfolio’s  positioning  in US Treasury bonds across the curve giving us a more liquid and efficient mechanism to shift portfolio duration in the event of an inflation shock. Until that manifests we will likely try to maintain a largely neutral duration positioning to the benchmark. 

JKC Asia Bond Performance 2023 – Fixed Maturity Fund April 2020 Update:

  • Mild recovery for the Asian HY market in April as new Covid-19 cases in Asia begins to taper down
  • Positive moves in US credit markets from Fed’s corporate bond purchase plans (including HY) has positive market sentiment effect, driving partial spillover into Asian HY markets
  • China credits outperform led by property and LGFV sector helped by domestic demand although foreign investors remain defensive
  • Asian credit market valuations at multi-year lows compared to US, providing attractive entry levels
  • The JKC Asia Bond 2023 fund average yield remains elevated (>15%) providing a good buffer against potential headwinds of a global recession
  • Short average duration of the fund and high diversification (122 names) should further help reduce volatility 

In April 2020, the JKC Asia Bond 2023 fund produced a total return of +2.57%. This return was broken down by +62bps from carry, +203bps from bond price movements and -8bps from fees. Risk assets rallied sharply as the world saw stabilization and declines in the growth rates of Covid-19 cases but particularly in Asia; suggesting that social distancing measures have been somewhat effective. As new cases continue to dwindle down, there has been some talk about easing lockdowns, especially in Italy and some states in the US. Credit markets also received a further boost from Fed’s announcements that it will provide USD2.3tn in monetary stimulus on 23rd March and 9th April which has had some positive spillover effects in Asia.

However, the recovery in Asian HY markets has not been as homogenous as the sell-off, with liquid China Property names leading the rally. This sector faces lower default risk, as China’s property market is already showing signs of a gradual recovery, with developers expected to announce sales growth of 8% MoM and 15% YoY in April according to independent research agency CRIC. In addition, most property companies have financial flexibility through their fixed assets, which could be sold, or companies could halt land purchase activities to shore up liquidity in the event of stress. That said, given the lower levels of leverage of Asian investors in general as well as the lower prevalence of fixed income ETFs in the region, we tended to see underperformance of sectors with a lower domestic ownership levels as foreign funds saw greater outflows during the month. Indeed, it is partly for this reason that we saw Chinese property and LGFV names outperformed in April given they are largely held by local banks and funds.

In contrast, credits outside of China experienced underperformance in April as onshore credit conditions for India and Indonesia remain constrained. In India, bank liquidity is already near capacity, as evidenced by the elevated system-wide loan-to-deposit ratio, which has been above 100 for the past 5 years. The sell-off was also partly exacerbated the closure of 6 local Indian currency bond funds that managed by Franklin Templeton with a combined AUM of US$3.5bn on account of a sharp drop in market liquidity in the domestic market. While India’s central bank subsequently opened a new credit facility (as much as 500 billion rupees) for mutual funds to help money managers avoid distressed sales of assets and calm investor concerns, it is clear the liquidity situation remains tight. So far the impact of this closure on the Indian offshore USD bond market has been limited to a few names although we will continue to closely monitor credit conditions in the domestic market which could have a spillover contagious effect.

On a more positive note, primary markets in Asia re-opened in April with USD14bn priced this month across 7 issuers. The pipeline continues to build up, comprising mainly high grade corporates and financials including PETMK and the new debutant XIAOMI which offers an opportunity to diversify exposure to the China tech sector. Most of the supply has come from large/benchmark issuers with relatively stronger fundamentals and we have yet to see any High Yield issuers issue new debt.

For the 2023 portfolio, given its buy and hold strategy and HY focus we have not made significant changes to the fund constituents in the past month as market volatility and challenged liquidity preclude trading at sensible valuations. Nevertheless, we do take some comfort that as a fixed maturity fund, the overall portfolio has a relatively short duration (average 2 years) and high diversification (122 line items) which should help limit the volatility impact for investors.

 

As of month end we had a fund cash level of 8.3% which provides good liquidity to take advantage of inexpensive valuations once the market stabilizes especially as the yield premium of both B and BB rated Asian USD bonds has climbed to an 8 year high vs equivalently rated US bonds in the past month. Meanwhile, with the 2023 portfolio offering a weighted average yield of over 15%, this already provides investors an excellent buffer against either further market volatility or any potential climb in global default rates as a result of the economic slowdown.

The information contained herein is issued by JK Capital Management Limited. To the best of its knowledge and belief, JK Capital Management Limited considers the information contained herein is accurate as at the date of publication. However, no warranty is given on the accuracy, adequacy or completeness of the information. Neither JK Capital Management Limited, nor its affiliates, directors and employees assumes any liabilities (including any third party liability) in respect of any errors or omissions on this report. Under no circumstances should this information or any part of it be copied, reproduced or redistributed. 

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