October 2019

JKC Asia Bond Performance

In October, the fund (USD unhedged share class) generated a total return of +0.18%. This compares to a return of +0.26% for the benchmark IBXX ADBI Index (Far East closing prices) over the same period, giving a net underperformance of -8bps. In terms of breakdown of the fund’s +18bps NAV performance for the month, -8bps came from price movements, +29bps came from interest carry, +7bps came from exposure to the JKC 2023 fund,  and –12bps from management and other fees, giving a gross total return (excluding fees) of +0.30% and a gross relative outperformance vs the benchmark (excluding fees) of +4bps. As of the end of October, the portfolio AUM (combined across all share classes) stood at USD59.3m, an increase of USD1.4m vs the level at the end September 2019, mainly due to gains in the EUR during the month.

 Despite a volatile month for US Treasury bonds in October with the benchmark 10yr issue swinging in a 30bps range, the Asian USD bond market ended the month slightly higher as IG cash spreads remained stable while HY got a boost from strong performance in the China property sector. Global risk appetite weakened in the early part of the month as concerns surrounding the US presidential impeachment, continued fears of a hard Brexit and stalling negotiations in the US/China trade talks created a cautious risk off environment. However, credit markets quickly recovered and rallied into month end led by US equities which climbed to new record high levels as US economic data continued to point to a non-inflationary environment giving room for the Fed to deliver one more 25bps rate cut at month end. In addition to the rate cut, the Fed also, in mid-October, announced plans for $60bn of monthly purchases of US Treasury bills and while this was driven by the need to shore up short term money markets in the US which had become increasing unstable in September and the Fed was clear that this should not be viewed as QE, the market still took this as a signal of more central bank easing. Meanwhile UK PM Johnson’s surprise breakthrough in negotiating a new withdrawal agreement with the EU provided a boost to market sentiment and although the deal did not get the chance to pass parliament ahead of the October 31st  leave deadline, it did significantly reduce the cliff edge risk of a no deal scenario.

In Asia, the China/US trade chatter continued to dominate the headlines and while the consensus view remains that the two sides are narrowing in on an interim ‘phase one’ deal, news flow continued to be volatile whip sawing from optimism and pessimism. Separately, China’s 3Q GDP release signaled a largely expected slowdown to 6.0% as the policy makers continue to engineer a soft landing in the world’s second largest economy. On a positive note, the weaker USD in October, in part helped by the rebound in the EUR on Brexit news, improved global emerging markets sentiment helping boost the Asian HY sector. Although, typical key beneficiaries of the weaker USD were frontier sovereigns such as Sri Lanka and Pakistan, it was the China Property sector that was the standout performer in October with that whole sector rallying ~2-3pts helped by lower than expected new issues and continued strength in contract sales driving demand from retail investors.

The JKC Asia Bond fund slightly outperformed the ADBI Index in October on a gross basis as we remained underweight long duration Philippines sovereigns and Chinese/Thai energy names, sectors which saw some the month’s biggest losses. Offsetting this however was our underweight exposure to the China HY property sector which was by far the biggest outperformer in the month while an underweight in Sri Lanka/Pakistan sovereigns and China LGFV bonds also weighed negatively on our relative performance. China HY property and LGFV’s, which have dominated new issues in 2019, have seen their weightings in the Index rise significantly during the year and while we did reduce underweight mismatch slightly in early October we remain comfortable with holding a small underweight in these sectors.

We ended October with an average portfolio yield of 3.55% (vs 3.49% a month ago and vs 3.58% for the ADBI) and an average portfolio duration of 4.82 (vs 4.90 a month ago and vs 5.01 for the index). Portfolio cash at the end of July stood at 5.4% (broadly unchanged from the 5.5% at the end of September).

Outlook

Global IG credit spreads remain rich, in our view, and going into year end when we would expect market liquidity to weaken, particularly with many investors looking to lock in the strong performance of the market year-to-date, we expect general risk taking to be subdued. Although trade war sentiment appears to be improving and Brexit risks have been postponed, we do not rule out any negative shocks to the market which are clearly not currently being priced in. One particular concern continues to be the flat yield curve in the US which could shift rapidly back to a steepening bias, particularly if the current monetary easing in the US proves to be excessive given the firm state of the US economy. History has shown the current level of 2yr-10yr UST spread has coincided with peaks in the US stock market and troughs in credit spreads and reversal of the current trend would have a significant negative impact on global USD IG bonds including Asia. However for the time being, political instability and global trade tensions have dominated the market attention and with a US election next year and a UK election next month, we expect the market will continue to focus primarily on this political risk. Nevertheless we do not believe the Trump/Johnson media show is an excuse to ignore fundamentals and we maintain a defensive positioning in our portfolio and a short credit duration bias.

Although the Asian HY sector is more rationally priced in our view and should be less impacted by macro shocks, it remains highly evident the bifurcation the market continues to grow with investors gravitating to the safe haven of liquid benchmark HY property bonds to the detriment of all other sectors. This has clearly led to a two tier pricing in the market where China property and select BB-rated industrial names are trading rich while the rest of the Asian HY market remains inexpensive but still largely shunned. We are not sure if this is partly also a symptom of investors reducing risk to protect y-t-d performance gains, in which case we could see this trend reverse again in early 2020 (similar to the trend we saw in early 2019). However we believe the best way to address this valuation mismatch is a highly diversified strategy across the whole risk spectrum in HY which provides  highly attractive yields without taking excessive single name exposures. For the JKC Asia Bond portfolio, holding HY through a position in the JKC Asian Bond 2023 fund allows for maximum diversification while still enjoying exposure to the compelling valuations of Asia HY. 

JKC Asia Bond Performance:

  • Asia High Yield bond market sees strong gains in October driven by a rally in China property
  • Improving US/China relations combined with a weaker USD helps drive positive market sentiment
  • Primary Issuance remained subdued this month also providing technical support to the market
  • The JKC Asia Bond 2023 fund gained +0.89% in the month as outperformance in China property (28% of the portfolio) is offset by some weakness in SOE university names
  • Fund ends the month with an average yield of 9.7% and average rating of BB-
  • Portfolio Individual line items grows to 132 names as increased diversification strategy is maintained

 In October 2019, the JKC Asia Bond 2023 fund produced a total return of +0.89%. This return was broken down by +57bps from carry, +40bps from bond price movements and -8bps from fees. The Asian HY rallied strongly during the month driven predominantly by the China Property Sector which saw reduced policy risks and a rapid cool-down of the land market which is likely to lead to a sequential improvement in property sales for 4Q19 ahead. Contract sales of developers which typically slow in October also remained firm while limited new issue supply from the sector further buoyed sentiment. Meanwhile we continued to see a risk-on tone in other sectors of HY as the US-China trade talks become tangibly more positive this month as markets expect the “Phase One” deal next month. A weaker USD meanwhile improved general sentiment to Asian EM from foreign investors

Looking at more regional news, Indonesia President Joko Widodo announced his cabinet this month which comprises of professionals and politicians. Overall, the appointments look to be market and business positive. With the cabinet now in place, the focus is likely to shift to what measures the government will implement to support growth. Decisions on mining subsidies/tariffs and any measures announced to stimulate the property sector while have particular sensitivity for the Indonesia HY market.

New primary issue supply in October was relatively muted which provided technical support for the Asian HY market. Sector diversity also remained limited with China Property and LGFV bonds continuing to dominate new issue flows albeit at lower volumes than market expectations. Going forward, we expect supply to tangibly increase as corporates look to capitalize on the recent rally and issue at lower coupon rates.

The JKC Asian Bond 2023 fund performance was largely buoyed by the rally in China Property which although we maintain an underweight weighting still accounts for 28% of the portfolio.  These gains were however offset by some single name weaknesses across the portfolio. This included two Chinese state-owned conglomerates linked to top universities, HKJHCC and TSINGH which faced concerns about their finances and debt-servicing abilities, this is despite both entities being owned and controlled by central Chinese government ministries and in our view maintaining strategic importance in the country. Indeed TSINGH later confirmed in a conference call that they are receiving funding help from a Credit Suisse led banking syndicate at L+220bps pricing levels which should help buoy sentiment to the name.

Despite the positive absolute returns in October, the yield on the portfolio remained at 9.7% whilst 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. With the environment of global falling interest rates and unrest in some other emerging markets – notably, Lebanon, Chile and Turkey – we expect the relative cheapness and “political stability” of Asia continue to drive increased interest in the asset class from Global/EM investors.

 

Trading wise, we continued to look for new names to further diversify the portfolio and raised line items to 132 from 129 names last month. Given the new supply in the China Property and LGFV sectors, we added Chengdu Airport Operator, SLSCCI 22s and China property developers, YLLGSP 23s and FTLNHD 22s. We also took the opportunity to trim our exposure to Indian banks YESIN 23s and INFLIN 23s as the Indian Financial Sector continues to face headwinds.

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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