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December 2022

JKC Asia Bond Performance 2025 – Fixed Maturity Fund December and FY22 Update:

  • Strong market gains for Asian HY bonds continues in December as the AHBI Index returns +7.1% for the month adding to the +16.1% gain in November
  • A rally mostly in the China property sector fuels the gains as improved government real estate stimulus and post Covid reopening optimism buoys sentiment
  • The 4Q22 rebound significantly reduces full year losses for the market although the HY Index still ends the year down -15.4%
  • The JKC Asia bond 2025 portfolio (USD share class) outperforms the index in December gaining +8.7% in the month
  • This takes the FY22 return for the portfolio to -7.5%, outperforming the HY index by a massive 787bps for the year
  • The fund even outperforms Asian IG market beating the ADBI Index by 394bps in FY22
  • Despite having material exposure to distressed China real estate in FY22, the portfolio still outperforms the overall market benefiting from nimble position taking, a defensive high liquidity posture for most of the year, good country sector allocation and a short duration bias
  • Going into 2023 we are optimistic the Asian HY market can return to profitability driven by a post-Covid China economic rebound, a more benign policy environment and attractive supply vs demand technicals for Asian HY bonds

In December 2022, Asian Fixed Income markets across IG and HY experienced another firm month following the strong performance in November. In particular, the Asian HY markets outperformed spectacularly with the Markit Asian HY dollar bond Index (IBXXAHBI Index) posting gains of +7.07% to finish the year above a previous peak in late August this year. Meanwhile our JKC Asia Bond 2025 portfolio (USD share class) outperformed the index in December returning +8.72%, driven mainly by the fund’s higher exposure to certain China real estate bonds which were the main driver of gains in the month.

For the full year of FY22, the portfolio (USD share class) returned -7.47%. Considering at one point the fund was down -23.4% (in early November) this was a substantial recovery from the year’s lows. Although, the fund does not have an official Asian HY benchmark, the performance can be informally compared to a -15.39% annual return for the IBXXAHBI Index, a significant outperformance.

Overall for 2022, it was a volatile year for Asian HY bonds as the market continued the singular trend of the significant negative returns that began in mid-2021. This downward price action was mostly driven by moves in the China real estate sector which at one point had dominated the Asian HY market but collapsed following a series of high-profile corporate defaults throughout 2021 and 2022. Indeed, by the end of the 3Q22 more than 50% of China property offshore bonds outstanding (HY and IG rated) were in default. While other sectors of the HY market such as Indonesia and India did fair better from a fundamental standpoint, the negative sentiment surrounding Chinese property overwhelmed market technicals and large-scale investor redemptions in the middle of the year forced broad-based selling driving healthier segments to also generate losses.

Exacerbating the situation for much of 2022 was an uncertain international macro environment as major central banks, led by the US Federal Reserve, aggressively tightened monetary policy to combat spiking global inflation. Elevated geopolitical tension both in Europe (on account of the Ukraine conflict) and in Asia (due to continued US-China cold war tensions) only served to fuel inflationary pressures.  Meanwhile Asian economies clearly suffered additionally from a sharp drop in the Chinese economy as the PRC government maintained aggressive policies to contain Covid outbreaks in the country, which lead to large scale lockdowns throughout the year despite the much of the rest of the world reopening.

However, given it was the collapsing Chinese real estate sector and the zero Covid policy of China that had the most profound impact on Asian HY bonds in 2022, it was clearly the reversal of these policies in the 4Q22 that triggered the massive market rebound. In early November following the 20th National Party Congress, Chinese authorities began signaling a series of measures to stimulate the economy. The real estate sector which had historically been a key pillar of the country’s economic growth pre-pandemic was specifically highlighted in these measures. While the government had for much of 2022 been hinting at support for the sector to little effect, It became clear in the past two months that the authorities were finally getting serious on trying to stabilize this critical segment of the economy. Announcements of large-scale financial support from state banks to selective developers provided to most clear evidence to date that the government was finally prepared to back up talk with tangible action. 

In December the halo effect for offshore China property bonds was further reinforced by the government and state banks finally talking specifically about supporting offshore creditors. In particular, Beijing ordered the top four state-owned banks to provide offshore loans to help property developers repay overseas debt according to Reuters in what seems to be the first concrete measures towards addressing developer’s offshore liabilities. In addition, we started to see a few developers like Country Garden and CIFI Holdings raise cash offshore via share placements which is likely to address offshore liabilities. Up to this point most stimulus were aimed at protecting domestic real estate buyers but finally there was a sense USD dollar bond investors would be recognized by the authorities  in the provision of financial aid.

In parallel with the stimulus talk was the PRC government announcing a series of measures to ease back on the hard zero tolerance stance on containing Covid across the country. Despite Covid cases aggressively spiking across China in November and December the authorities maintained this reopening stance and by the end of the year it became clear China would not be able to return to a lockdown position.  After three years of pent-up demand in China, particularly in the services sector, news of Covid relaxation was met by massive market optimism as key economic metrics across the country had plummeted to unseen lows by year end. 

In the Asian HY bond sector, the response to Chinese stimulus was rapid and significant. Beginning in mid-November and continuing until year end, Chinese property bonds in particular have staged a massive rally and, as valuations have richened, this has created an uplift trade across all segments of the asset class significantly reducing the years overall losses. In fact, in December while over 5ppts of the Index’s 7.07% gain was down to the property sector all segments generated strong gains.

Over the year the JKC Asia Bond 2025 portfolio significantly outperformed the Index achieving better returns in 9 of the 12 months of the year and ending 2022 with 787bps of outperformance. Much of this was achieved by taking a cautious and defensive positioning in the early part of 2022 holding elevated cash and maintaining strict diversification discipline to avoid over exposure on both a single name and sector basis. We began the year with a large underweight in China Property, the worst performing sector, and only switched to an overweight in mid-year when the sector valuations massively cheapened. We also benefited from under exposure to other troubled sectors such as Macau gaming, Pakistan and banks subordinated debt while overweight positions in strong performing sectors such as India and Indonesia also provided an uplift. Of course, our continued short duration mandate also clearly helped the relative performance of the fund in a rising interest rate environment and partly explains why the fund was even able to outperform the Asian IG index (IBXXADBI) which returned -11.4% in the year. Notwithstanding the duration effect, the outperformance is still impressive given the HY market has a much higher exposure to China property bonds than the IG market.

2023 Outlook

We expect 2023 to start in strong fashion as the optimism surrounding the post Covid re-opening of the Chinese economy drives market sentiment. Admittedly, the path to reopening up China’s mammoth economy is unlikely to be smooth and linear. With a sudden change in pandemic response away from the draconian measures put in place, we are cognizant of the potential risks as the virus sweeps through communities. That said the market will likely look through this to focus on the medium-term growth outlook and the positive impacts it will have on domestic consumption. One of the key beneficiaries of renewed domestic consumption and border easing is likely to be the Macau gaming sector who have seen its bonds rally significantly in the past two months. Indonesia commodity producers will also likely gain as Chinese companies begin restocking inventories.

The China property sector is likely to remain volatile despite the clear step change in market perception. Whilst opening up financing channels for developers are positive and can help them alleviate short-term liabilities, it is unlikely to cover the majority of liabilities and debts of the sector. Instead, developers will need help to spur property demand by the government in order to generate enough cash flow to pay down liabilities. However, recent policies measures have yet to address the weak demand of property sales as analysts predict a -29% YoY drop in contract sales for December. We do expect contract sales growth will return in the 1H23 helped by a lower base effect but the path to recovery will be shallow as developers need to rebuild the trust of their customers. For this reason, the initial beneficiaries of the fundamental rebound will be stronger, mostly SOE developers which have already seen their bond prices significantly move. A much more profound driver of the fortunes of the Asian HY market in 2023 will be how the government and management of defaulted issuers address their restructuring plans and more specially how offshore creditors will be treated in these negotiations. We strongly expect very mixed results as decisions to bail certain developers will be highly politically motivated. Maintaining a nimble and diversified market positioning in this environment is highly favoured.

For other sectors of the market, we are very optimistic. As the reopening of the China HY property bond primary market is not expected in the near term and as it is unlikely non-property issuers will sufficiently fill the gap, there will be an increasing supply/demand mismatch which will drive strong demand for existing paper particularly in the perceived more stable markets of India and Indonesia. We will look to maintain an overweight in these segments in 2023. Finally it is worth noting that overall market interest rates are significantly higher at the start of 2023 than they were a year ago. This crucially will provide an important yield return buffer for the HY market as higher accruals can offset overall single name volatility and leaves us optimistic that barring unforeseen global event risks the Asian HY market can return to profitability in 2023 after two years of losses.

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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