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May 2020

JKC Asia Bond Performance:

In May, the fund (USD unhedged share class) generated a total return of +1.69%. This compares to a return of +2.24% for the benchmark IBXX ADBI Index (Far East closing prices) over the same period, giving a net underperformance of -55bps. In terms of breakdown of the fund’s +169bps NAV performance for the month, +125bps came from price movements, +30ps came from interest carry, +26bps came from exposure to the JKC 2023 fund, and -12bps from management and other fees, giving a gross total return (excluding fees) of +1.81% and a gross relative underperformance vs the benchmark  of -43bps. It should be noted that bond pricing mismatches due to market disruption and volatility during the COVID outbreak continued to have an impact on relative performance in May. On a  ytd basis, the portfolio has performed  in line with the index on a gross  basis. As of the end of May, the portfolio AUM (combined across all share classes) stood at USD58.4m, a significant increase from the USD56.3m level at the end April, as positive gains in the bond prices was enhanced by a 1.4% gain in the EUR vs the USD during the month.

Following the sharp selloff in March, the Asian bond market maintained its upward trajectory in May adding on to April’s initial price rebound. Indeed, the year-to-date total return for the IG heavy ADBI swung back into positive territory last month, primarily led by credit spreads as UST bond yields remained range bound for most of the month. In fact, the Asian credit spread tightening outperformed almost all other global regions last month as the massive cheapening of Asia seen in March began to reverse. Consequently, the average yield premium of Asian BBB rated bonds (over US BBB rated bonds) decreased over  20bps during the month while the outperformance for Asian HY issues was even greater. Nevertheless, yield premiums still remain above historical averages, positioning the region for further potential outperformance going forward.

The pattern for Asia underperforming in the 1Q and outperforming in the 2Q is intuitive given a similar trend has been seen in the main cause of 2020 market volatility, i.e. the COVID-19 virus. Indeed, while Asia was the first region to be impacted by the virus in January, it has also been the first to control the outbreak and begin the path to economic recovery, particularly in North Asian countries such as China, Korea, Taiwan and Hong Kong were infection growth has fallen rapidly in the past month without the need  to fully shut down their economies. That being said, it is somewhat surprising that the countries outperforming in the bond market in May, namely India, Indonesia, Pakistan etc, are regions that have found it more challenging to contain the outbreak while the real champions of controlling the virus have underperformed. In this regard, it appears that notwithstanding the underlying fundamental cause of the market volatility, it has ultimately been valuation that has been the main driver of market moves, and outperformance in May has largely been a factor of a rebound of those countries that had most underperformed previously.

One notable exception to this has been Sri Lanka, which has, by a considerable margin, been the region’s worst performer in 2020 and although we did see a modest recovery last month it continued to lag other frontier sovereigns. This likely reflects increased investor discrimination within the EM world as fears of rising sovereign defaults, as exemplified by Argentina’s missed payment last month, leads to an overall separation of winners and losers. Sri Lanka’s default is not a foregone conclusion but with the sovereign bonds still trading less than 60cents on the dollar and another rating downgrade last month (S&P downgraded Sri Lanka to B-) it seems a large segment of the market is starting to price in this scenario.

Another of the region’s big underperformers in May was Hong Kong. This followed news of the mainland government’s announcement at the annual NPC to introduce new national security laws on the SAR, bypassing the  HK legislature. Fears of a return of civil unrest in the city on the back of this move led to a period  of volatility HK stocks and bonds alike with the Hang Seng Index in particular falling 5.6% on May 22nd, its biggest one day drop since 2015. The impact on HK’s USD bonds was quite muted given these are mostly represented by large financially healthy companies, however it still caused the country to lag the rebound elsewhere in Asia. Later in the month an announcement by President Trump to revoke Hong Kong’s  special trading status with the US triggered some further concerns but with the US move light on detail, the HK bond market has yet seen little impact from the news.

Aside from bond price rebounds, another sign of the market recovery in Asia was the improvement in bond liquidity. Liquidity, as measured by the average bid/ask price spread of investment grade bonds recovered from ~1.5pts in March to ~1.0pts in May, still elevated compared to historical levels but a significant improvement over the past two months. For HY bonds, the market admittedly still remains two tier with Chinese properties  seeing a further improvement in liquidity in the past month while Chinese Industrial names continue to face poor liquidity and a challenged trading environment.

The JKC Asia Bond fund underperformed the benchmark in May mainly on account of the defensive positioning of the fund, notably the high cash balance and underweight exposure to long duration Indonesia sovereign bonds and Indian corporates which, despite still being highly exposed to the COVID-19 pandemic and economic fallout, still rallied significantly in May.

We ended May with an average portfolio yield of 3.61% (vs 4.00% a month ago and vs 3.62% for the ADBI) and an average portfolio duration of 5.02 (vs 4.80 a month ago and vs 5.31 for the index). Portfolio cash at the end of April stood at 8.5% (compared with 8.7% at the end of April).

Outlook

While there has clearly been an improvement in sentiment in recent weeks on the back of post  COVID economic recovery expectations,  we believe the rebound will remain disjointed and volatile. As China has recently  demonstrated, even as countries try to return to some degree of business normality, overall economic activity will likely remain suppressed for the rest of the year which could cause some serious pressure in more levered areas of the global economy. Notwithstanding huge fiscal and monetary support from government and central banks, global default rates are likely to rise in 2020 which would continue to put pricing pressure on credit markets across the world.

For Asia, we continue to believe a risk of rising defaults is better priced in compared to other regions given the large yield premium of the region, particularly for HY bonds. However idiosyncratic risk  will remain elevated for the rest of the year and we continue to favour a highly diversified approach to our high yield exposure. We have reduced our underweight of China property bonds in recent months as this sector as proven to be extremely resilient to economic headwinds, although we remain at the short end of the credit curve where price volatility will be less extreme.

For the investment grade market, although the rising geopolitical tensions between US and China continues to grab most the headlines, the much more important question remains the sustainability of the rally in EM markets such as Indonesia and India which significantly outperformed in May, in stark contrast to the expected negative economic impact from the COVID-19 virus. Recent dollar weakness has clearly helped with EM sentiment, but as these balance of payment deficit countries continue to face a slower global growth environment we expect market pressure will return, particularly if global sovereign defaults increase. Our continued underweight of Indian corporate bonds reflects expectations of another global risk pull back in the next few months as the economic reality of the global recession becomes more apparent while in Indonesia we have scaled back our underweight slightly.

That said, we remain conscious our cash overweight could drag relative performance if sentiment continues to improve and, in light of this, we will look increasingly for new investment opportunities. A good example is new issues which can offer significant pricing discounts at a time of uncertain outlook. For example bonds issued by Malaysian SOE Petronas rallied as much as 30pts in the past month following their cheaply priced primary issue in mid-April while in May we subscribed to the attractively valued HKLSP 30 bond which gained 3pts in the first day of trading.  Our high cash buffer allows us the opportunity to find such investment opportunities in the primary market providing potential additional upside in a volatile environment.

 
JKC Asia Bond 2023 – Performance
  • Recovery continues for the Asian HY market in May as concerns of another round of lockdown wanes
  • Indonesian and Indian credits outperformed this month as they played catch up to China’s rally last month, portfolio also benefitted from several positive special situations in the month
  • Asian USD Primary bond markets remain in full swing for IG markets; whilst HY primary markets reopen mostly to the Chinese Property Sector
  • Fundamentals for China HY Property sector (38% of portfolio) continued to see tangible improvement as May contracted sales further strengthened
  • The JKC Asia Bond 2023 fund average yield remained above 14% providing a good opportunity to capitalize on market recovery
  • Short average duration of the fund and high diversification (124 names) should further help reduce volatility

In May 2020, the JKC Asia Bond 2023 fund produced a total return of +3.05%. This return was broken down by +63bps from carry, +250bps from bond price movements and -8bps from fees. With concerns of another round of lockdowns waning, sentiment continued to turn more risk on. In particular, EM investors were looking beyond the expected 2Q GDP contractions to put more cash to work this month as Indonesian and Indian credits outperformed the Asian HY market in May. Fundamentals are expected to see slight rebounds as the Indonesian government has announced it will gradually open shopping malls, restaurants and entertainment sites from June in an attempt to jump-start the economy. In addition, the country also issued US$4.3bn of foreign currency bonds in maturities as long as 50 years which is quite impressive given that foreign investment from EM investors have largely been frozen since the outbreak of Covid-19.

In the China HY property market, there seems to be a clear trend of recovery amid a mild policy backdrop. According to one of China’s largest real estate agencies, CRIC, May contracted sales of the Top 100 property developers experienced a 12.2% YoY increase on average, which further strengthened from the average of a 0.6% YoY increase in April. Furthermore, the 22nd May politburo meeting did not focus much on property as a stable policy tone was reiterated. This should continue to provide a healthy backdrop for Chinese HY property bonds.

Whilst India and Indonesian names outperformed, oil and gas related names remained under pressure this month as commodity prices remained depressed. In particular, Chinese oil and gas drilling equipment maker and service provider HILOHO bonds fell after the company was unable to obtain SAFE’s approval to remit cash onshore to pay for the USD 165m bonds due in 22nd June 2020 on a technical issue. Although the company has other options to cover the redemption including approaching current bond holders with an exchange offer proposal, significant execution uncertainty is likely to weigh on the name until its near term liquidity issues  are addressed.  We hold  the longer  dated 2022 bonds and although the refinancing issue is a concern, we still believe there remains  value in HILOHO as it has a relatively high recovery value with a leading position in a niche market, relatively good track record during the previous oil down cycle and relatively low liability to asset ratio.

On the flip side, the  portfolio benefited from several  positive special situations  during the month.  VEDLN bonds rebounded 20pts after management proposed a take private deal which would potentially improve the capital structure of  the group to the benefit of bondholders. Dr Peng bonds jumped 15 points after its own bond extension proposal was approved  by bondholders during the month and CARINC bonds gained 10pts on reports SOE Beijing Auto will potentially take a 21% stake in the company. 

On another positive note, primary markets in Asia have re-opened for the HY market. The HY pipeline comprising mainly of Chinese Property Developers, which includes FTHDGR and the REDPRO which offers an opportunity to extend duration on issues. 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.

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 poor 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 (124 line items) which should help limit the volatility impact for investors.

As of month, end we had a fund cash level of 6.5% 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 remains high compared to historical averages. Meanwhile, with the 2023 portfolio offering a weighted average yield of ~14%, 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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