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October 2022

JKC Asia Bond 2025 – Fixed Maturity Fund October 2022 Update:

  • A massive divergence between Asia and the rest of the world in October
  • Global markets risk sentiment stabilized as Fed policy for the rest of the year well telegraphed by Chair Powell and priced in by the market
  • However, Asia fixed income markets tangibly underperformed and decoupled from both DM and non-Asia EM markets this month
  • China was clearly the key culprit for Asia weakness as the 20th National Party Congress (NPC) in Beijing was poorly received by investors
  • Chinese HY bonds were especially weak driven by further credit events in the China Property space
  • We do expect market volatility to remain heightened in the near term driven mostly by continued credit events such as extension offers and restructuring proposals and have been selectively trimming high-cash priced bonds in China.

In October 2022, the JKC Asia Bond 2025 fund produced a total return of -8.58%. This return was broken down by +56bps from carry, -906bps from bond price movements and -8bps from fees. The return can be compared to a -9.24% drop in the Asian HY Index (IBXXAHBI Index)

October was a month characterized by a huge divergence of performance between Asia and the rest of the world. With the 10-year UST yields largely holding around the 4% handle, global macro conditions seemingly stabilized during the month as expectations of two more 75 basis point rate hikes by the Fed (Nov and Dec) seemed largely priced in by the market. Admittedly some instability in UK politics did provide a little uncertainty for Europe although this seemed to do little to dampen investor sentiment in Western economies and news of Rishi Sunak replacing Liz Truss as UK Prime Minister and a U-Turn on the latter’s disastrous “mini budget” did further fuel a relief rally in US and European stocks and credit markets. Even global Emerging Markets saw some recovery as a slowdown in USD appreciation buoyed sentiment.

This rebound was however not reflected in Asia which massively underperformed all other parts of the world for both Equities and Fixed Income. Indeed, the MSCI Asia ex Japan Index (MXASJ Index) fell -6.1% in October compared to an +8.0% climb in the USD S&P Index. Similarly in credit, the iTraxx Asia IG CDS Index widened by 46bps while simultaneously the US Investment Grade and European Crossover CDS Indices both tightened by 18bps and 86bps respectively. Such a divergence of performance between Asian and developed markets is quite rare but even more unusual was the fact that Asia widened at a time when EM spreads (as measured by the CDX EM Index) also tightened significantly.

Isolating the driver of these divergent moves it was clear the main influence was China as investors reacted sharply to developments during the 20th National Party Congress (NPC) held in Beijing during the month. At the NPC President Xi reiterated the country’s strict Covid-zero policy, which dampened any optimism for a full reopening of the country’s borders anytime soon and confirmed many investors’ views that there will be no easy or quick exit from the zero-Covid policy. In addition, President Xi hinted at an aggressive rollout of more policies to achieve ‘common prosperity’ goals that could adversely affect the country’s commercial environment. The Xi administration’s clear priority of political stability and national security over economic growth and reform was perhaps most clearly highlighted by the politburo reshuffle which saw the exclusions of key economic reform figures such as Liu He and He Lifeng, who would have been viewed as more “market friendly” appointments, in favour of Xi loyalists. Meanwhile exacerbating the situation was continued pressure and economic sabre rattling by the US as President Biden announced further curtailment on China’s access to cutting edge semiconductor technology. In response to negative geopolitical overhang, all China risk assets (both fixed income and equities) saw sharp selloffs as investors began pricing in a less market friendly China. That being said, we believe the initial reaction to the selloff had been somewhat overdone as the market is still confounded on whether or not there truly is a paradigm shift in China’s economic environment.

Naturally Asian HY, which continues to be dominated by China issues, bore the brunt of the market weakness with the Market AHBI HY Index falling -9.2% in the month to a new all-time low since its creation 10 years ago. China property bonds today only account for a 13% weighting in the index but another massive collapse in prices saw that sector continue to be the main driver of the decline. In fact, the selling was quite indiscriminate, impacting defaulted, distressed and high-quality developers alike with even IG property names such as Vanke and Longfor, not included in the HY index, also seeing a massive drop in October.

One of the major factors affecting this continued weakness in sentiment was the surprise announcement of defaults and payment difficulties from companies that had previously been assumed to be ring fenced away from the credit problems. Indeed among the many policy announcements, China has made to try to stabilize the property sector in recent months has been allowing certain companies to access new financing via China Bond Insurance Co Ltd (CBICL) guaranteed interbank notes (i.e. government credit enhancement). The assumption had been that the limited number of developers given access to this scheme would be prevented from defaulting. However, the surprise failure of Shanghai developer CIFI Group, which had previously issued under the scheme but subsequently announced a suspension of all offshore debt service in October and Shanghai Government owned Greenland Holdings which was similarly in the CBICL short list but last month proposed a restructuring of all USD bonds, demonstrated such government support would not be extended to supporting foreign creditors. The Greenland news was particularly surprising as the GRNLGR 22 bond fell >80pts on the news. The market has therefore begun to shift opinion that all private Chinese developers in the country face the real risk of default or restructuring, even previously viewed untouchable names like Vanke and Longfor. The surprise resignation of Longfor’s Chairperson Wu Yajun on October 31st only further fuelled these fears.

Away from China property, there were some bright spots in the China Industrial sector. Chinese conglomerate FOSUNI saw its USD bonds recover somewhat last month after the Shanghai-headquartered conglomerate announced it signed a framework agreement to sell a 60% stake in Nanjing Nangang Iron and Steel United Co. to Shagang Group for up to CNY 16bn. Subsequently, Bloomberg reported in late October that FOSUNI plans to sell up to USD 11bn of non-core assets within the next 12 months to focus on its consumer-discretionary business. We also saw the Hongqiao group successfully raising new financing via onshore bonds. However, these positive stories were massively offset by the drop in China property ensuring China weighed most heavily on the Asian market.

In the non-China space, credits were more mixed and less volatile although we also saw some weakness across these sectors. As the INR and IDR currencies continued to decline against the USD, this did fuel some softness in the Indian renewables space as investors begun to focus on companies’ FX exposure given their wholly INR-revenue base vs USD-denominated debt. Macau gaming credits meanwhile gave up some recent gains as frustration over the slow reopening of the market due to COVID was exacerbated by licence renewal concerns. Finally, Filipino power company SMC Global Power (which the fund has no exposure to), saw its dollar bonds fall 26 points last month as a spike in input costs such as coal has been a cause for concerns for the company’s bottom lines.

In terms of the JKC Asia Bond 2025 portfolio, we did once again outperform the Index for the 4th consecutive month, but this did not prevent the fund from experiencing a material drop in October due to the exposure to China which is unavoidable on account of the country’s large weighting in the market. In fact, we continue to have an overweight in China property on the account of many names being stripped out of the index due to payment default or short tenor but notwithstanding this, our single name positioning has allowed us to outperform despite the higher weighting to this weak sector. 

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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