JKC Asia Bond 2025 – Fixed Maturity Fund October 2023 Update:

• Asian High Yield (HY) market outperformed Investment Grade (IG) bonds in September as the short duration bias of HY and of the JKC Asia Bond 2025 fund insulates exposure to US interest rates volatility.
• Despite a short-lived rebound in early September, China property bonds continued to drag on the Asian HY market in September as the rebound in physical sales was disappointing despite recent aggressive government policy support.
• Mixed performance from China Property bond restructurings also weighed on sentiment as Sunac’s successful reorganization plan was offset by Evergrande’s surprise restructuring failure on account of government investigation into the company’s management.
• Nevertheless, our reduced weighting of China property (<8% of AUM) allows other better performing sectors (e.g. India and Indonesia) to more than offset real estate losses and the fund to eke out a gain of +0.62% (vs +0.15% for the HY Index) in September 

Rates volatility was a key theme for global credit markets last month after the US Federal Reserve maintained a hawkish bias in its latest policy meeting. Indeed the “dots projection” for the September 20th FOMC meeting signalled that rates may be cut by only 50 bps in 2024 (vs a 100bps anticipated cut in the previous meeting). This was due to a bullish outlook for the US GDP growth as the labour market data continued to paint a picture of a solid US economy while economic activity data all surprised on the upside. Coupled with the pressure related to a potential federal shutdown (which was ultimately averted), we saw Treasury yields reacting sharply, with 10-year yields breaking above 4.6% for the first time since 2007. The move higher in yields was mostly seen at the long end of the US Treasury curve as the short-dated yields remain anchored to the current near term interest rate outlook. Nevertheless, the 2-year/10-year yield spread remains inverted (it stood at -47bps at month-end) indicating more potential upside for long term yields going into the 4Q23. Unsurprisingly, the significant move in Treasury yields in a relatively benign credit spread environment caused weakness in Asian IG bonds, particularly in long duration issues. Indeed, the Asian IG index even underperformed the HY market which benefited from a significantly shorter average duration.

While the main factor behind the outperformance in the Asian HY bonds (vs IG) was the shorter duration of this segment, the Chinese property sector continued to be a significant driver of the intra-month volatility both on the upside and downside. In fact, a China property driven rally in the early part of the month was offset by the same sector pushing the market lower towards the end of the month. September ended up being another negative month for China property bonds. Non-China sectors eventually dictated the small positive gains of the market during the month.

At the start of September optimism was high. The Chinese government had just announced a slew of new stimulus measures to revive physical sales demand across the nation including a critical relaxation of downpayment requirements, of home purchase restrictions and of mortgage financing rules.  Meanwhile Country Garden which had been one of the main underperformers in August announced the curing of two of its missed USD-bond coupons right before the expiration of the 30-day grace period. In addition, the company was able to offer additional incentives which managed to get creditors’ approval for its RMB bond extension. Despite these last-minute payments, the probability of a full-blown offshore debt restructuring remains high.

Whilst these policies largely benefitted developers that have not yet defaulted, the market also saw an improvement in sentiment amongst the defaulted names. Liquidity in defaulted developers’ bonds that were trading at low to mid-single digits seemingly improved after the successful offshore restructuring of Chinese developer Sunac which gathered an impressive 98% votes in favour of the restructuring proposal. The chance of striking a successful restructuring talk for Sunac increasingly developed after March this year when the developer signed a restructuring support agreement (RSA) with an ad-hoc group of investors representing more than 30% of Sunac’s outstanding offshore bonds. According to the RSA, bondholders are to receive new debt that will mature two to nine years from now. They will also be able to swap Sunac debt into shares of its property management subsidiary, Sunac Services Holding. By mid-month, the Chinese property sector had rallied by 10% (albeit from a low base).

However, sentiment towards property developers soured after bellwether developer China Evergrande Group surprised the market when it announced that it needed to reassess the terms of its proposed restructuring just days before the bondholder vote was scheduled to take place. The announcement was made worse by the fact that two completely different explanations were given, one related to disappointing sales and a second one related to the Chairman’s apparent arrest by Chinese authorities. Evergrande Chairman Hui Ka Yan was allegedly being investigated by authorities over possible transfers of assets offshore, providing an unnecessary distraction and hurdle to offshore restructuring proceedings. The fact this arrest was made after two years of negotiations on the eve of the restructuring vote only added to the market’s confusion and disappointment and raised significant concerns on the success of other developers’ restructuring talks. China property bonds sold off sharply towards the end of the month, erasing gains made earlier.

From a portfolio perspective, the impact on the fund of this weakness was very small as the exposure of the fund to the Chinese property sector is now limited and the fall was more than offset by gains in other segments, particularly in India and Indonesia.

In India, mining conglomerate Vedanta Resources dominated headlines after the company sounded out a voluntary exchange offer for two of its USD tranches which would extend the maturities by three years alongside an upfront payment of at least 50 cents for the notes due January 2024. This came after the company engaged Morrow Sodali to conduct a bondholder identification exercise in August and after it subsequently held meetings with bondholders. With more concrete plans for an extension, Vedanta bonds reacted positively, up 2 points, as the company also laid out concrete plans to obtain new credit facilities from credit funds and banks. It is expected that Vedanta would obtain net proceeds of USD750m from a private placement with Oaktree Capital and Trafigura. Concurrently, it is in advanced talks with Standard Chartered and JP Morgan for almost USD3bn of refinancing. 

In September, the JKC Asia Bond 2025 (USD share class) fund returned 0.62%, outperforming the Asian HY index by 47bps. This was mainly driven by our overall short duration exposure, our defensive positioning in China property, and our overweight to Indonesia and India which were the best performing countries. Going forward we continue to review our exposure to high beta and distressed sectors factoring in a challenging environment for bond restructurings, particularly in the China real estate sector. Our aim is to maximize returns from more stable sectors within the Asian HY market.