December 2019

JKC Asia Bond Performance:

In December, the fund (USD unhedged share class) generated a total return of +0.09%. This compares to a return of +0.35% for the benchmark IBXX ADBI Index (Far East closing prices) over the same period, giving a net underperformance of -26bps. In terms of breakdown of the fund’s +9bps NAV performance for the month, -8bps came from price movements, +31bps came from interest carry, -1bps came from exposure to the JKC 2023 fund,  and -13bps from management and other fees, giving a gross total return (excluding fees) of +0.22% and a gross relative underperformance vs the benchmark (excluding fees) of -13bps. It should also be noted, a pricing mismatch between custodian and index prices at year end cost the fund -15bps of relative performance and excluding this impact the fund would have outperformed the Index by 2bps on a gross basis in December, we expect this mismatch will reverse to the benefit of the portfolio in early 2020. As of the end of December, the portfolio AUM (combined across all share classes) stood at USD59.5m, an increase of USD1.0m vs the level at the end November 2019, mainly due to gains in the EUR during the month.

Although typically a quiet month, we went into this December with political uncertainty as the US congress impeachment of Trump, UK elections and US/China Trade negotiations all hung in the balance. Meanwhile for Asia, concerns of defaults in the Chinese onshore market and rising political unrest in India also provided a  significant overhang for the HY market, weighting on investor sentiment going into year end.

However, market jitters were short lived as a raft of positive headlines mid-month, while not entirely removing economic overhangs, did go a long way to steady investor uncertainty. The unanimous decision by the FOMC to hold US rates unchanged in December was not in itself a major surprise but subsequent statements and projections by the Fed committee cemented the view that 2020 is likely to see interest rates on hold for the foreseeable future and while the Treasury curve did steepen slightly on the back of some stronger than expected US payroll numbers, the move was quite muted. Meanwhile more than offsetting the 10bps rise in 10year yields was a significant rally in developed market credit spreads in December, particularly for US high yield bonds which tightened a massive 45bps in the month. Clearly positive news  surrounding a long awaited breakthrough in phase one trade negotiations between US and China was a key catalyst for the rally while headlines of the conservative party’s emphatic win in the UK election was also welcomed by the market on the hope of breaking some political deadlock in Europe. 

While Asia did see some benefit from the positive global risk sentiment, the region was a laggard in December as concerns over the stability of the Chinese domestic bond market weighed heavily on performance, particularly in early December when some high profile onshore defaults of government linked entities raised concern on the government’s ability and willingness to financially support weak SOE’s. Indeed, one segment which came under particular pressure was the university sector which, representing as much as 1% of the Asian ADBI index in mid-2019, saw a sharp fall December as concerns increased over these issuers’ high levels of leverage and ambiguity regarding government support (despite being majority owned by the central government).  This had a knock on effect on the private sector with many Chinese industrial bonds seeing low investor appetite going into year end when liquidity is typically at its lowest. The underperformance of Asia versus development markets was most noticeable in the Asia yield premium with Asian BB-rated 5yr bonds ending the year with an average yield premium of >190bps over equivalent US bonds, even higher than the level seen at the end of 2018. (For B-rated bonds the premium was >800bps).

As explained, the JKC Asia bond fund gross underperformance in December was mostly due to a pricing mismatch at month end mainly effecting long duration bonds which is expected to be reversed in early 2020, excluding this the fund would have performed flat to the benchmark. From a sector perspective, our fund benefited from an underweight in Chinese industrial HY bonds (including university names) and an overweight in India/Indonesia HY bonds although these relative gains were offset by our underweight of EM sovereigns such as Sri Lanka and Pakistan which unsurprisingly rallied in the risk on environment as well as our underweight in China  property HY bonds.

With the December move, the JKC Asia Bond fund ended the year with an annual return of 10.02%, as the Asian bond market saw its biggest gains since 2009. While the gains were broadbased across all sectors and regions, long duration bonds (as to be expected) saw the highest returns with ASEAN sovereign and quasi-sovereign issuers such as INDON (Indonesia sovereign), PHILIP (Philippines sovereign), PKSTAN (Pakistan Sovereign), PERTIJ (Pertamina), PLNIJ (PLN) and TOPTB (Thai Oil) in particular all outperforming.

We ended December with an average portfolio yield of 3.58% (vs 3.61% a month ago and vs 3.57% for the ADBI) and an average portfolio duration of 4.75 (vs 4.76 a month ago and vs 5.01 for the index). Portfolio cash at the end of July stood at 6.1% (down from the 6.5% at the end of November).

Outlook

New year, new risk appetite and following a trend we have seen in the past few years we expect investor demand for HY paper should improve in early 2020 as annual performances reset. Adding to the positive sentiment is news of further monetary stimulus in China over the new year break with a 50bps RRR cut on Dec 31st and pledges by Chinese premier Li Keqiang to bolster capital access for the private sector. Admittedly interest rate cuts in China have proven less and less effective in recent years and a bigger problem remains over incentivizing risk averse Chinese banks to lend to HY private corporates, however PBOC pro-activity does typically help drive domestic asset manager sentiment. With Chinese USD bond yields at very  attractive levels from a global perspective, positive momentum provided by the recent US/China trade negotiations and the significant rally seen in developed market credit and equities we  believe this provides a  good investment window Asian HY bonds.

On this basis, we will look to selectively increase our HY weighting in the JKC Asia bond fund although we will largely prioritize defensive liquid names such a short dated (<2years) China property which should see lower volatility in the event of any unforeseen pull back. For IG, bond valuations remain expensive from a historical perspective but are still attractive from a geographical standpoint and so we will prioritize looking for global relative value opportunities such as Indonesia quasi-sovereigns and any underperforming Indian IG names. 

 

In terms of duration last month we have moved back to a slightly short duration vs the benchmark as the Fed’s current loosening cycle appears to have paused and we continue to see the best value for IG at the shorter end of the curve.

JKC Asia Bond Performance 2023:

  • Flat performance for the 2023 fund in December as strength in China property issuers offset by an overall defensive stance by Asian investors and weak sentiment towards industrial names at year end

  • Significant volatility of Chinese industrials driven by weakness in government linked university sector and continued fears of rising onshore defaults…

  • However a late rally in the market fueled by China/US trade breakthrough and Chinese domestic monetary stimulus at year end improves sentiment going into 2020

  • Asian HY valuations have cheapened significantly in 4Q19 (vs US HY) further adding to potential for a rebound in early 2020

  • The JKC Asia Bond 2023 fund with a high average yield (9.9%), significant diversification (129 lines) and short duration, well positioned to capitalize on any rally

In December 2019, the JKC Asia Bond 2023 fund produced a total return of -0.05%. This return was broken down by +59bps from carry, -56bps from bond price movements and -8bps from fees. The Asian HY fund performance was largely flat due to two opposing factors during the month. On the positive side, the rally in China Property bonds (30%  of the portfolio) was maintained in December as market participants continued to view the sector as a  safe haven going into year-end although, these gains were once again offset by weakness in the Chinese Industrials which remained under pressure in early December and only saw a mild recovery towards the latter half of the month.

 Nevertheless, sentiment did improve significantly at month end as the phase one agreement of the US/China trade deal triggered a positive repricing in HY bonds globally while an announcement of Chinese monetary stimulus measures over the new year holiday left the market extremely well positioned for a rebound, particularly as Asian HY bonds had been significant underperformers (vs US and Europe) in the 4Q19 and therefore offer an attractive relative value going into 2020.

 In terms of specific news flow, Chinese University names dominated headlines this month as the sector saw a large negative repricing in early December amid escalating concerns about these issuers’ high leverage and fears over a  weakening of state backing. Indeed,  although university linked companies remain majority owned by the Chinese central government (through the ministry of education) and, in most cases, engaged in policy driven strategically important initiatives, a lack of transparency in the sector has clearly tested investor patience for bonds which, until recently, had been viewed as government supported entities  In particular, driving the weakness was Founder Group, a conglomerate spun off from Peking University whose management raised doubts about its ability to pay an offshore dollar bond on 24th December 2019. While the Founder Group was subsequently able to cooperate with its bondholders, (most of which are also government entities), to extend the repayment deadline to Feb 2020 and the bonds did see some recovery at month end, clearly sentiment for the sector has been damaged and indeed whilst the extension is a positive development, we remain cautious in the sector and have reduced our weighting as noted in last month’s update.

 In another sign of volatility in the Chinese Industrial Sector, we saw Chinese textile company, RUYIGR repay its $345 million US dollar bond on Dec 18th ending weeks of speculation whether or not the luxury clothing giant would be able to gather enough funding to meet its debt payment and, in fact, the RUYIGR 19 bonds were offered at a 30pt discount just 2 days before the maturity date. While the portfolio benefitted from the subsequent rebound in the RUYIGR 22s which rallied >15pts after the repayment, this does highlight the significant volatility in the Asian HY market justifying our  highly diversified investment strategy.

 New primary issue supply in December continued to drop off as we reached the end of the year, providing technical support for the Asian HY market. That said, sector diversity remained poor with China Property and LGFV bonds continuing to dominate new issue flows albeit at lower volumes than market expectations. Going forward, we expect new issue supply to pick up back in 2020 given the significant maturity wall by the LGFV sector this year.

Despite the flat performance in December, the JKC 2023 fund ended the year with an annual return 10.33%, mainly driven by the strong gains in the 1H19 while the highly diversified profile of the portfolio limited the negative impact from the market volatility seen in the 2H19. Meanwhile with Asian HY bonds underperforming global HY markets in recent months, the yield premium of Asia (vs US) has increased substantially with both double B and single B rated Asian bond yield premiums ending the year at their highest level in over 2 years. While navigating default risk in the HY market always remains a challenge, the high yield level of Asia (with the portfolio currently enjoying a 9.9% average yield), combined with the high diversification of the fund (with 129 line items at year end) and short average duration provides an excellent buffer to absorb any unforeseen volatility while still being able to participate in an expected market recovery in early 2020 when risk appetite returns and recent macro stimulus should provide a tailwind to risk assets.  

 

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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