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August 2021

JKC Asia Bond 2023 – Fixed Maturity Fund Update
  • Asian USD HY Bond market in August rebounded from the July lows, as larger cap developers decoupled from Evergrande risk
  • Interim reporting season for Chinese property companies brings some clarity to regulatory impact on the sector fundamentals.
  • Other sectors and geographies in Asia very stable as Asian investors try to diversify away from China.
  • JKC Asia Bond 2023 portfolio continued to show lower volatility compared to Asian HY indices, largely due to our disciplined diversification strategy and specific underweight to high beta China property names
  • The JKC Asia Bond 2023 fund ended August with an average yield of 10.0% while duration continued to come down (currently 1.1 years), issuer line items stood at 126 (across 172 positions)

In August 2021, the JKC Asia Bond 2023 fund produced a total return of +1.43%. This return was broken down by +57bps from carry, +94bps from bond price movements and -8bps from fees.

The Asian USD High Yield bond market partially recovered last month following the large selloff in July, largely driven by the Chinese property names as investors sought opportunities to pick up bonds at cheaper valuations. That said, the one name that arguably triggered the July fall (i.e. China Evergrande) continued to trade lower as headline noise persisted, sustaining weak market sentiment for the name. Admittedly not all the news on Evergrande was negative in August as the company did demonstrate some progress in asset sales to help ease its near term liquidity burden. For example the company made several asset divestment announcements including the sale of a small stake in its 36% owned Shengjing Bank., the sell down of an 11% stake in HK listed software company Hengten to a consortium of investors including Tencent and reports of a potential sale of its HK headquarters building to Yuexiu Property for HKD10.5bn. However, offsetting this was continue reports of the company facing severe difficulty servicing trade payables to key contractors at several projects across China. Exacerbating the situation was a 1H21 profit warning which showed a sharp fall in profitability for its key real estate development unit and although the results ultimately released at month end did show the company had delivered on its promise to significantly cut debt and lower leverage, it was viewed by the market as too little/too late. Evergrande bonds ended the month trading in the low 30’s suggesting that without external support, some form of debt restructuring is inevitable.

Going forward Evergrande will likely trade at the market assumptions of liquidation value were assumptions in the market range significantly but at current pricing levels, (high 20’s at the time of writing), the direct impact of Evergrande on the overall Asian HY market should be a lot more limited going forward. Of course, weakness in Evergrande can have a secondary impact on the market to the extent it creates fear of contagion risk throughout the whole property sector which remains the single largest subset of the Asian HY bond market. A correlated sell-off of China property names was a key feature of the July weakness and therefore we were very encouraged to see a decoupling of Evergrande and other large cap high beta property names such as Sunac, Kaisa and Yuzhou for much of August which ultimately helped support the market gains during the month.

A factor driving this decoupling was the fact nearly all developers released their 1H21 financial results in August which allowed investors to focus on underlying fundamentals and less on market rumors and gossip which had in our view significantly influenced sentiment in the previous month.

Assessing the results of the 42 Chinese property developers under our coverage we did observe several patterns in their 1H21 numbers. Firstly, the whole sector exhibited extremely strong contract sales growth during the period (average +40% y/y). This is unsurprising, in our view, as it reflects the government’s determination for developers to bring down balance sheet debt through asset reduction, as dictated by the three red lines policy launched last year. Naturally the flip side of all developers’ accelerating sales, particularly at a time of strict government price controls, was a material fall in margins across the whole sector with gross margin on average falling 3-4 percentage points for the names we cover. However, regarding leverage itself, we did see the government’s desire for lower gearing realized with average net debt / equity ratios (one of the three red line ratio measures) falling materially for most developers.

Although the performance of some property companies, in terms of margin preservation and debt reduction, was better than others thereby allowing better credit differentiation, it was interesting to see the degree to which government policy was clearly influencing the sector as a whole. Sentiment for China property bonds remains very weak as demonstrated by bond valuations with average yields across the sector trading at multi-year highs. However, we hope and believe that the good faith that developers have shown in tailoring their businesses to suit the government objective of reducing property price inflation and reducing financial risk across the sector will ultimately result in so form of credit easing in the coming months which we believe will be critical to improve liquidity and therefore help drive a rebound in investor credit sentiment for the sector. Until we do see a visible softening policy shift, however, we will maintain our current relatively cautious stance towards the sector which, despite being a large component of our portfolio, is our largest risk underweight position vs the overall Asian HY investment universe.   

Away from China property, the market continued to be relatively benign in August. The initial market fears around the Chinese education sector diminished in August with international school operator Bright Scholar (BEDUUS) rebounding +4 pts after the company released an announcement to say that the new government rules should have limited impact on its business and it also launched plans to buy back 10% of its bonds to help stabilize prices.

Chinese distressed asset manager China Huarong rose a massive +29 points in August after the company announced the introduction of state-backed strategic investors led by China Ministry of Finance backed Citic Group. In addition, the company also released its long-delayed FY20 and 1H21 results which although showing a widely expected significant asset write down for the FY20 numbers, also showed a stabilization of earnings in the 1H21. Although the 2023 fund does not have direct exposure to the Huarong bonds, we do see this indication of government support as positive for sentiment towards the Chinese HY market, particularly SOE’s and LGFV’s which typically rely on government cash flows to support their credit profiles. Furthermore, the massive gain in Huarong’s bonds during the month shows how quickly negative sentiment can reverse once positive support measures for a company (or sector) are announced.

In the non-China space, India and Indonesia HY markets remained very firm, primarily driven by the increase in commodities prices. Indian oil and gas and mining conglomerate Vedanta bonds rose 0.5-4.5 pts after the company published a good set of results with strong cash generation on the back of soaring commodity prices and solid production. Elsewhere Indonesian textile company Pan Brother’s saw its bonds rise 5 pts as most of the company’s bank creditors have sold their loans to the textile maker to SC Lowy, who appears to be supportive of Pan Brother’s plans to restructure the debt.

For the 2023 portfolio we continued to be balanced and disciplined with our sector diversification approach remaining highly cautious on the China property market volatility. With subscription inflows we continued to scale up our position in some Indian and HK names such as YESIN 23 after the India bank produced some stronger than expected FY21 results. In Hong Kong we added to our positions in Asian regional logistic property company ESR and HK property company NWDEVL 22. Within China we increased our exposure to higher quality Chinese property names such as SHIMAO and AGILE. We ended the month with an average portfolio yield of 10.0% and an average duration of approximately 1.1 years. The portfolio held 172 positions across 126 individual issuers.  

The information contained herein is issued by JK Capital Management Limited. To the best of itsĀ  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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