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June 2020

JKC Asia Bond Performance:

In June, the fund (USD unhedged share class) generated a total return of +1.59%. This compares to a return of +1.86% for the benchmark IBXX ADBI Index (Far East closing prices) over the same period, giving a net underperformance of -27bps. In terms of breakdown of the fund’s +169bps NAV performance for the month, +113bps came from price movements, +30ps came from interest carry, +29bps came from exposure to the JKC 2023 fund, and -13bps from management and other fees, giving a gross total return (excluding fees) of +1.72% and a gross relative underperformance vs the benchmark  of -14bps. As of the end of June, the portfolio AUM (combined across all share classes) stood at USD59.9m, an increase from the USD58.4m level at the end May, driven by the combination of positive gains in the bond prices and a 1.2% gain in the EUR vs the USD during the month. 

The rally in the Asian dollar bond market continued for a third month in June as credit spreads tightened further while US Treasury yields remained largely range bound. Indeed, with the 10yr US Treasury bond yield virtually unchanged during the month, Asia’s IG market was mainly driven higher by an average 20bps tightening of credit spreads taking the benchmark ADBI index back to pre COVID levels (+2.7% ytd). Meanwhile, stable currency markets and ongoing liquidity support from the Fed continued to underpin lower rated EM markets with frontier sovereigns such as Sri Lanka, Mongolia and Pakistan all significantly outperforming in June.

Curiously the Asian market rally was maintained despite further negative headlines during the month as concerns over weakening US/China trade relations, fears over backlash in Hong Kong from the introduction of new security legislation and a credit rating downgrade in India each did little to dampen positive investor sentiment. Meanwhile a significant pick up in primary activity during the month saw new paper quickly absorbed by strong investor demand. A total of USD36bn of new bonds were issued in June, up 56% m/m and, despite being the highest fund raising levels since the start of the COVID crisis, most of this new paper saw impressive positive gains after launch.

In the high yield market, bonds also rallied although performance continued to be selective with most the gains coming in China Property sector which benefitted from a strong rebound in fundamentals as the China economy began to reopen following the COVID shutdown. Contract sales of China property companies has largely returned to pre-COVID levels as companies maintain positive growth targets for the full year. On the other hand, demand for HY industrial names in Asia remained mixed as concerns over a potential rise in COVID driven default rates weighed on investor sentiment, specific sectors such as Indonesian property,  Chinese oil service companies and Indian NBFC’s saw some month end weakness on this basis.

The JKC Asia bond underperformed the ADBI index in June largely due to our sizeable underweight in Sri Lanka and Pakistan which were two of the best performing markets in June. Indeed the Sri Lanka sovereign bonds gained 22% on average in June recovering some of its significant ytd losses. On the other hand, our underperformance was limited by our decision to reduce our cash weighting in early June by taking positions in selective new issues (such as INDOIS 50, NWDEVL Perp, HUADIA Perp) which all displayed strong gains following their respective launches.  The fund also benefitted from an increased exposure to  ASEAN where the fund recently increased its weighting in Malaysia, Indonesia and Singapore.

We ended June with an average portfolio yield of 3.42% (vs 3.61% a month ago and vs 3.26% for the ADBI) and an average portfolio duration of 5.14 (vs 5.02 a month ago and vs 5.43 for the index). Portfolio cash at the end of April stood at 7.0% (compared with 8.5% at the end of May).

Outlook

Typically we would go into July expecting a decline in market activity and lower liquidity on account of the summer holidays, although with few options to travel it remains to be seen if market participants will take a break or maintain the recent pick-up in activity. Indeed, the increase in primary issuance could potentially be maintained given the low yield environment and likely pent up pipeline given the weak issuance markets earlier in the year. Issuing new paper now could also be a last opportunity for corporates before election madness begins to dominate the market and potentially drive volatility higher in the 3Q.

At the very least it looks inevitable that politics will remain a key driver of the market in the near to medium term as US/China relations will stay a center piece of the upcoming  US presidential election. So far most of the geopolitical noise has had a limited impact on the Asian bond market (HUAWEI bonds for example have remained on a consistent upward trajectory since April). However if a potential COVID second wave begins to pressure the US economic rebound we would not be surprised to see US/China rhetoric ramp up in the coming months. Meanwhile within Asia, most economies continue to enjoy a modest recovery from the worst of the COVID crisis although sharply rising cases in some countries such as India does remain a major overhang and we maintain an underweight on India for this reason.

Valuation of Asian IG bonds have richened on a relative value basis in recent weeks compared to US equivalents although the Asian yield premium still remains above long term historical averages. With the Fed likely to maintain their lower for longer stance on interest rates and expectations of continued stability in Asian EM currencies against the dollar we believe technicals for the Asian IG bond market remain robust. Consequently we will continue to look at primary markets as an opportunity to further add selective risk in higher yielding IG names or high quality BB rated HY papers. Although most of Asia’s relative value remains in the single-B  rated space we remain cautious of rising defaults in the industrial sectors and will therefore maintain a defensive highly diversified exposure to lower rated bonds to reduce single name idiosyncratic risk. 

JKC Asia Bond Performance 2023:

  • Risk-on sentiment persisted for the Asian HY bond market in June amidst a backdrop of the global economic rebound and “fear of missing out”
  • Global central bank monetary stimulus combined with a stable USD kept sentiment for EM markets positive
  • However, fears of a second wave of infection and potential reinstatement of selective lockdowns in western economies tempered optimism to an extent
  • Asian USD primary bond markets came back into full swing lead by China property sector which maintains high investor demand on the back of improving fundamentals
  • The JKC Asia Bond 2023 fund ended June with an average yield at 13.1%
  • Asian single-B yield premiums remain well above historical average, still providing a good opportunity to capitalize on market recovery
  • Short average duration and high diversification (124 names) of the fund should further help reduce volatility 

In June 2020, the JKC Asia Bond 2023 fund produced a total return of +3.29%. This return was broken down by +65bps from carry, +272bps from bond price movements and -8bps from fees. June saw positive economic data coming from the US which helped to further fuel the ‘risk-on” sentiment here in Asia, with a surprise upside in US May retail sales. A stable USD also provided good support for the Asian EM market, underpinning a rebound in frontier markets such as Sri Lanka, Pakistan and Mongolia. Despite this, there are risks that loom ahead including fears of a second wave of infection/reinstatement of selective lockdowns globally which tempered the rally somewhat. On the other hand, geopolitical concerns reignited as China passed the National Security Legislation in Hong Kong, appeared to do little to impact sentiment on Asian HY bonds.

Specifically, the China HY Property sector was the best performing sector in Asia HY in 1H20, according to Barclays research, generating a total return of +2.15% vs a decline of -1.35% for the overall Asia HY index. Performance was largely driven by fundamentals as most developers saw a strong recovery in contracted sales as construction activities and new launches resumed after the COVID lockdown. Contracted sales of 27 major developers increased by an average of 12% YoY in 1H20, pushing sales to 42% of full-year targets. In addition, June saw the normalization of the offshore primary market for property developers, with approximately USD 5bn of new HY China property bonds sold.

Whilst China HY property names dominated the primary issuance markets, we did also see some gaming names issue USD bonds this month, which included Macau gaming names like Wynn Macau and MGM China and Cambodian gaming company, NagaCorp. We believe we will continue seeing more primary market activity particularly in the China HY property sector as many of the corporates are ready with NDRC quotas.

Despite the positive market momentum, negative rating actions continued this month for certain names including Indonesian property developer, Modernland Realty which saw it bond prices drop on the back of a rating downgrade by S&P, citing the possibility of liquidity stress over the next 2-3 months. On a more positive note, bonds of Indian-listed metals and mining giant Vedanta Limited enjoyed a strong rally this month as its shareholders approved the voluntary delisting of the company on June 25th a move that would substantially improve the capital structure of the company to the benefit of bondholders. In addition to the privatization plans, oil prices moves and the broader market risk-on sentiment for lower dollar price laggards, should help maintain the Vedanta price recovery.

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 unideal liquidity conditions still preclude trading at sensible valuations. The fund broadly performed in-line with the overall Asian HY market last month as gains in our high beta positions was offset by our underweight in Sri Lanka which was one of the best performing sectors in June, recovering from its sharp decline in earlier months.

We ended the month with an average portfolio yield on the portfolio of 13.1% vs an average duration of approximately two years.  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. Line items on the portfolio remained at 124 although with a cash balance at 6% this still gives us scope to add selective opportunities as they come available. 

The information and material provided herein do not in any case represent advice, offer, sollicitation or recommendation to invest in specific investments. 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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