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September 2020

JKC Asia Bond Performance:

In September, the fund (USD unhedged share class) generated a total return of -0.47%. This compares to a return of -0.46% for the benchmark IBXX ADBI Index (Far East closing prices) over the same period, giving a net underperformance of -1bps. In terms of breakdown of the fund’s -47bps NAV performance for the month, -57bps came from price movements, +28ps came from interest carry, -6bps came from exposure to the JKC 2023 fund, and -12bps from management and other fees, giving a gross total return (excluding fees) of -0.35% and a gross relative outperformance vs the benchmark  of +11bps. As of the end of September, the portfolio AUM (combined across all share classes) stood at USD60.6m, a decrease from the USD62.1m level at the end July, as the decline in bond prices was exacerbated by a -1.8% fall in the EUR vs the USD during the month. 

After largely consistent positive performance since March, the rally in Asian dollar credit markets paused in September as fears over a potential stall in the US economic recovery combined with a pickup in pre-election concerns. Indeed, US equity markets which had been leading global asset prices higher for most of the year saw a significant increase in volatility last month, particularly in large cap technology names which had arguably been the biggest beneficiaries of massive liquidity injections from the US Fed since the beginning of the COVID crisis. The US central bank itself tried to keep on message and reaffirmed its dovish stance during its September FOMC rates meeting but with growing concerns of a potentially disordered presidential election, a risk off tone began to permeate through all asset markets.  With US interest rates remaining stable for the month this bearish sentiment was largely seen through credit spreads with Asia IG CDS widening ~10-20bps over the course of the month.

The risk off tone was also felt in currencies with the USD recovering some of its recent losses. In addition to the flight to quality trade, the delay of a new US fiscal stimulus package also likely helped support the firmer USD which gained 1.8% against the EUR. Naturally this weighed on Asia’s EM and frontier markets and although China bucked this trend as improving economic data helped maintain RMB stability, the credit selloff was seen broadly across all Asian markets. Asian HY bonds underperformed IG during the month as two of the largest HY issuers in the region (China Evergrande and Sri Lanka) both experienced significant volatility during the month. China’s largest developer, Evergrande, saw bonds fall after reports of a potential refinancing challenges related to large liabilities coming due in early 2021 and although a large part of the decline was reversed after the company announced large scale support from strategic investors, this still weighed heavily across the China  property sector. Sri Lanka sovereign bonds meanwhile fell sharply after Moody’s downgraded the  country’s rating to its lowest ever level of  Caa1.

The JKC Asia Bond fund outperformed the index in September on a gross basis mainly on account of our underweight exposure to Sri Lanka and China HY property although this outperformance was tempered slightly by some risk exposures to Indian financials and Indonesian property names which dragged on returns.  Trading wise it was a quiet month for us as we preferred to maintain cash buffers going into the potentially volatile US election season and did not see many compelling opportunities in the new issue market. Notably we did decide to exit fully our Huawei bonds which has been a profitable position for the fund but given the growing geopolitical risk between US  and China no longer offers compelling  value at these levels, in our view. We ended the month with an average portfolio yield of 3.08% (vs 2.89% a month ago and vs 2.86% for the ADBI) and an average portfolio duration of 5.25 (vs 5.26 a month ago and vs 5.48 for the index). Portfolio cash at the end of September stood at 4.2% (compared with 5.6% at the end of August mainly on account of the lower EUR).

Outlook

We expect market volatility will remain elevated for the month ahead as US  election rhetoric heats up while news in entering the month of president Trump contracting COVID adds an additional layer of uncertainty to the market. For this reason we do not see a reason to significantly add risk at this stage and will maintain our slightly defensive stance on both duration and credit and wait for any further price correction before adding risk.

Indeed, the move in China property bonds last month was a demonstration as to how quickly the credit market will react to negative news in the current climate with the Evergrande curve falling as much as 20pts intra-month  before recovering most of its losses by month end. As much as this does raise concerns it also presents opportunities given the China  HY property sector remains in  good shape from a macro perspective and many better quality developers would offer attractive investments in the event of any further price correction. Although we currently maintain a risk underweight exposure to the HY sector (most China property positions held through IG names) we will remain vigilant of potential investment prospects.

 

JKC Asia Bond 2023 Performance:

  • Weak month for Asian HY bonds as volatility increases in global risk assets
  • China HY Property sector underperformed as driven by the negative headlines around EVERRE and the “Three Red Lines Policy” by the Chinese government
  • Frontier sovereigns also weaker as USD rises and Sri Lanka sovereign gets a two notch downgrade by Moody’s (to Caa1)
  • JKC Asia Bond 2023 down -0.7% in the month but significantly outperforms overall Asian HY Market (AHBI Index -2.07%) on account of highly diversified strategy.
  • Some positive upside from special situations, exchange offers and corporate buybacks also benefits the fund.
  • The JKC Asia Bond 2023 fund ended September with an average yield of 11.1% while duration continued to come down (currently 1.75 years)
  • Cash exposure increased to 7% giving us good resources to capitalize on potential volatility pick up going into year end
  • Despite the weaker monthly performance, Asian yield premium (vs US) declined slightly in August but remain well above historical average, providing a good opportunity for investors to still capitalize on market recovery

In September 2020, the JKC Asia Bond 2023 fund produced a total return of -0.70%. This return was broken down by +60bps from carry, -122bps from bond price movements and -8bps from fees. The Asian HY market saw weak performance in September reflecting the risk-off sentiment seen across all global markets. The dollar recovery particularly put pressure on EM sovereign bonds while in China the usually firm property sector saw weakness as investors took to profit taking following the consistent rally since March.

Triggering specific concerns on Chinese real estate names was investor fears surrounding the governments introduction of its “Three Red Lines” policy to control total debt of developers. Although the ultimate aim of this policy would be to strengthen balance sheet and improve the overall financial stability of the sector fears began to grow that the government’s introduction of fund raising limits on certain more levered developers could create near term liquidity risk. More specifically this policy states that Chinese regulators would evaluate developers according to three key ratios (adjusted debt / assets, Net debt / equity and total cash / short-term debt). Bond Issuers would then be scored either Red, Orange, Yellow or green according to how many of these limits ratios they breach with the implication being a limit to the amount of additional debt raising the company would be  permitted until leverage is reduced. While we welcome the policy, which is ultimately positive for Asia HY credit markets, it would create greater credit discrimination in the near term which could put additional pressure on the sector.

It is an unfortunate circumstance that some of the largest developers in the country are some of the most highly geared with China’s largest developer by assets, China Evergrande, a good example. Indeed Evergrande bonds saw significant volatility in September as concerns surrounding the three lines policy were exacerbated by the company’s large refinancing burden for 2021. Adding to the pressure were unverified reports last month that the company had approached the government for financial support which the company later denied. At one point the bond issued by Evergrande and its onshore subsidiary Hengda fell as much as 20pts over 3 days, before staging an equally dramatic recovery following a management announcement that it had secured financial support from several key strategic investors. As the country’s largest property company and indeed the largest issuer of USD bonds in the Asian HY market, Evergrande’s price volatility understandably had a profound effect on the over China property sector which accounts for ~40% of the Asian HY market, and naturally was a large driver of Septembers market moves.

In a separate but equally dramatic move, the second largest issuer in the HY market (the Sri Lanka Sovereign) also saw a significant price correction last month after Moody’s downgraded the country’s rating to Caa1 its lowest ever level. The Sri Lankan sovereign curve which accounts for 5% of the HY index fell 10-15 points reversing most of its July/Aug rebound. A rally in the USD added to the negative pressure on frontier sovereigns  with Pakistan also seeing weakness in September.

Fortunately for the JKC Asia Bond 2023 portfolio, the fund holds  no position in either Sri Lanka or Pakistan bonds and maintains a significant underweight in Evergrande bonds. Although the fund is not benchmarked against any HY Index, the fund did outperform the Markit IHBI Asia HY index by 137bps in September reflecting our underweight in these names and further demonstrating the benefit of our highly diversified strategy. The fund also benefited from some positive special situations in September with exchange offers launched in the JINANC 20’s CHIWIN 21’s and a management bond buy back for the GERLSP 22’s providing significant uplift for those issues.

We ended the month with an average portfolio yield on the portfolio of ~11.1% and an average duration of approximately 1.7.  After a series of recent bond redemptions, we have allowed our portfolio cash to increase to 7.1%. Given our expectation of further market volatility going into year-end we believe this cash will give us a good liquidity to pursue investment opportunities that might arise as a result of this.

 

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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