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July 2020

JKC Asia Bond Performance

In July, the fund (USD unhedged share class) generated a total return of +2.07%. This compares to a return of +2.40% for the benchmark IBXX ADBI Index (Far East closing prices) over the same period, giving a net underperformance of -33bps. In terms of breakdown of the fund’s +207bps NAV performance for the month, +177bps came from price movements, +28ps came from interest carry, +14bps came from exposure to the JKC 2023 fund, and -12bps from management and other fees, giving a gross total return (excluding fees) of +2.19% and a gross relative underperformance vs the benchmark  of -21bps. As of the end of July, the portfolio AUM (combined across all share classes) stood at USD64.3m, an increase from the USD59.9m level at the end June, driven by the combination of positive gains in the bond prices and a 4.8% gain in the EUR vs the USD during the month. 

A continuation of COVID driven loose monetary policy across the world’s major economies helped sustain the rally the global risk assets, including Asian credit markets, which saw their fourth consecutive month of strong gains in July. As the US economic recovery continued to be hamstrung by rising virus cases and a hostile domestic political environment in the lead up to the November presidential elections, the Fed maintained its highly dovish bias, driving a further flattening of the US Treasury yield curve. The 10yr UST bond yield ended the month 13bps lower reaching month end level of 0.53% while the 2yr/10yr spread also declined to a 4month low. Meanwhile fund flows into US IG corporate bond portfolios, buoyed by assumed fed support and recent USD weakness, underpinned a further tightening of credit spreads and, combined with the lower UST yields, helped drive another strong month for global dollar bond returns.

Of course, the aforementioned dollar weakness was perhaps the biggest development in July as the US currency corrected sharply during the month (the DXY seeing its biggest one month drop since 2010). Admittedly the dollar has been viewed as overvalued for some time although a key catalyst for the sudden drop was likely news that EU leaders had successfully negotiated its EUR750bn COVID stimulus bill  which would allow supranational bond issuance by the European Commission for the first time, bringing the European economic block one step closer to fiscal consolidation. The EUR’s sharp rally against the USD was mirrored by most Asian currencies which, on average, gained 1-2% against the dollar during the month.

As with the global trend, Asian markets also enjoyed lower credit spreads in July although, in contrast to May and June, the region did underperform the US last month with the yield premium between Asian and US dollar bonds (for both IG and HY rating segments) widening marginally during the period. The reason for Asia’s underperformance is not fully clear and although it would be easy to blame rising geopolitical tensions between the US and China, there was not a clear pattern of underperformance for trade war sensitive names. Asia’s underperformance vs the US is also somewhat surprising in the context of the fall in the USD in July which typically provides a strong support to EM markets. In our view, Asia’s relative underperformance was most mostly technical driven given the large flows into the US IG markets. Another strong month of primary bond issuance in Asia for July (USD39.7bn) also potentially impacted the market technicals, in our view.

In terms of segmental performance in Asia, the pattern of recent months was continued with long duration credit outperforming short duration and high yield outperforming investment grade bonds. As a natural consequence of this, it was once again low rated frontier governments such as Sri Lanka and long dated sectors such as Indonesia and Philippines sovereigns as well as Chinese internet names that lead the gains. Meanwhile the safe havens of Korea and Singapore continued to underperform. 

The JKC Asia bond underperformed the ADBI index in July, largely due to our regulatory underweight in Sri Lanka which remained by a considerable margin the best performing market, returning an average of +13.5% in the month. Our underweight of long dated Philippines sovereign bonds also cost us in relative performance in the month although this sector continues to look extremely expensive in our view and we will maintain our underweight. On the positive side we saw good outperformance in our Chinese sovereign and bank positions. Given the significant rally in the EUR in July we were extremely active in adding positions to maintain our fund cash level in its target range and therefore to avoid becoming too risk underweight given the positive underlying tone to the market. We particularly targeted new issues which offered good liquidity and attractive valuations and, in total, added 24 new positions to the fund which also further improved the diversification of the portfolio.

Finally, it is worth mentioning we made our first investment on the domestic RMB bond market in July via the HK/China Bond Connect platform (the purchase of a short-dated China Government policy bank bond). This inaugural investment opens up the fund to a new USD14trn asset class which provides huge diversification benefits given the low correlation between the USD and RMB bond markets.

We ended July with an average portfolio yield of 3.04% (vs 3.42% a month ago and vs 2.84% for the ADBI) and an average portfolio duration of 5.46 (vs 5.14 a month ago and vs 5.57 for the index). Portfolio cash at the end of July stood at 4.8% (compared with 7.0% at the end of June).

Outlook

We expect currency volatility will remain a theme of the market in August given the sharp extent of the USD fall in July. Although we believe the dollar should remain on a depreciating path over the medium term, we would not be surprised to see a near term pull backs in the exchange rate as US policy will likely be tailored to ensure market stability. Currency volatility clearly presents a challenge to our maintaining a target duration and risk profile for the fund although we believe focusing on deploying excess cash on recently issued liquid bonds should help maintain fund flexibility particularly as primary issuance and overall market volumes could decline in August, we will also continue to make direct investments in US Treasuries to manage duration of the fund.

Meanwhile we have become more constructive on the near-term prospects of the market given the Fed’s clear focus on maintaining easy monetary policy, even at the risk of stoking inflation. This could change if we see a sudden shift in COVID cases or breakthrough on a vaccine, however this does not appear likely in the near term and hence the reopening of western economies (particularly after recent signs of a second wave in several countries) will probably continue to remain cautious. Consequently, we have moved to a slightly more neutral duration bias against the benchmark, in the past month, and reduced our cash overweight.

Clearly, a side effect of the COVID virus this has been a significant ramp up of negative US geopolitical pressure on the PRC government. Whether this is part of a long-term plan of economic containment of Asia by China hawks in the Trump administration, or simply a tactic to distract from the weak domestic economic performance of the US as we head into the presidential election cycle, is not entirely apparent. However, it does seem clear the rhetoric will continue to ramp up in the 3Q as we approach the November voting date, particularly if Trump lags in the polls. So far, the actual impact of this noise on Asian and indeed Chinese dollar bonds has been negligible and while there does remain the obvious tail risk of a policy mistake, we see worst case scenario reports of a weaponization of the USD against Chinese institutions as grossly overstated. Nevertheless, we believe the trend of an internationalization of the RMB will only continue in the current environment further emphasizing the importance of our recent entry into the Chinese domestic bond market as a further source of risk diversification for our fixed income strategies.

 

 

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

  • Asian USD HY Bond market tone remained positive for the month of July despite disappointing key economic data from the US
  • The rally dismissed rising US-China geopolitical tensions which typically have a small impact on domestically focused Asian HY names
  • Important single name price moves during the month centered around M&A activity with headlines in CARINC, GRNLGR and VEDLN driving bond price moves.
  • HY primary markets continued to be dominated by China property issuances mostly via repeat issuers. High investor demand on the back of improving fundamentals support secondary performance
  • The JKC Asia Bond 2023 fund ended July with an average yield of 12.1% while duration continued to come down (currently 1.75 years), issuer line items increased to 126 (across 135 positions).
  • Despite the strong positive returns, Asian single-B rated yield premiums (vs the US) increased in July and remain well above historical average, providing a good opportunity for investors to still capitalize on market recovery

In July 2020, the JKC Asia Bond 2023 fund produced a total return of +1.92%. This return was broken down by +61bps from carry, +139bps from bond price movements and -8bps from fees. The Asian HY market enjoyed a good month of returns despite the weak macro data coming out of the US as Q2 GDP marked a quarterly decline of -32% YoY. US-China tensions which continued to flare up this month continued to have a muted impact on the Asian HY market which remains dominated by domestically focused industries.

The Chinese car rental sector was one of the best performing sectors this month in Asia HY led by CARINC bonds which gapped up by 8-10pts. The move followed an announcement that Beijing-government backed BAIC Group will acquire approximately a 28.91% stake in CARINC and prompted Moody’s to place CARINC on review for upgrade which should help improve the company’s funding access and weak liquidity profile. Rival Car Rental company EHICAR also gained in July as the sector showed signs of recovery from the COVID downturn.

The Chinese HY Property sector also performed well following strong sales figures according to independent research firm CRIC. According to the report, the top 100 Chinese developers saw July sales up 40% YoY and in the 7M20, developers achieved contracted sales growth of about 9%. In more specific headlines, Chinese property company GRNLGR saw its bonds drop temporarily fall 1-2 pts after its major SOE shareholders Shanghai Land Group Ltd and Shanghai Municipal Investment Group Corp announced they would reduce their stake in the company by 17.5%. However, concerns were quickly dispelled by management, reassuring during an investor call that the sold shares will go to other SOE’s, avoiding breaching the minimum 40% state-ownership threshold in the change-of-control provisions in the Chinese developer’s bonds. 

Away from China, Indian oil and gas producer and mining conglomerate Vedanta Resources’ privatization headlines continued as the company announced it is seeking an acquisition-loan facility with a size of USD3.6bn-USD3.7bn to back the take private deal. In addition, the company also aims to price a USD senior secured 12-18month bond to fund the deal, we maintain the view that the privatization of the list-co. And full consolidation with the parent will be positive for Vedanta’s USD bonds.

For the 2023 portfolio, we continued to add to positions in July as the strong rally in the EUR increased our portfolio cash on account of share class currency hedging. Although the new issue pipeline continued to remain robust, most names coming to the market were repeat issuers and likewise we predominantly deployed our cash into toping up existing positions. Nevertheless, line items in the fund did still grow as we added some new names in China and India increasing the number of positions to 135 (across 126 issuers) and reducing cash to 5%. In July the fund broadly performed in-line with the overall Asian HY market as gains in our high beta positions was offset by our underweight in Sri Lanka which continued to be one of the best performing sectors in July, particularly as the country signed a USD 400m currency-swap agreement with the Reserve Bank of India to bolster its foreign-currency reserves and help provide economic stability amid the COVID-19 pandemic.

We ended the month with an average portfolio yield on the portfolio of ~12% and an average duration of approximately 1.7years.  Given the yield premium of Asian HY (compared to equivalently rated US HY bonds) continues to remain at elevated levels, particularly for single-B rated issues, Asian HY bonds still offer good upside potential despite the recent rebound in our view.

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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