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

• The month of August saw macroeconomic data from China’s economy dramatically flipping from better-than-expected in Q1 to worse-than-expected in Q2.
• It appears that the Chinese economy has suffered from a deflationary shock – with the weakness in the Chinese property market being the main reason.
• Meanwhile on the policy front, the Politburo has signalled more willingness to support demand across consumption, investment, and property, albeit through targeted measures.
• Negative headlines concerning one of China’s largest developers, Country Garden saw its bonds tumble as the company failed to make coupon payments due in early August.
• Selling pressure spread to the rest of the Asia credit market on fears of defaults by more property developers and also missed payments on wealth products by Zhongrong International Trust (ZIT).
• At August end we saw a raft of new policy announcements suggesting the government was finally getting serious on addressing the problems in the real estate sector which should provide some uplift in the month ahead.

There was largely a risk-off mood in August as investors globally focused their attention on the weaker-than-expected Chinese macroeconomic data including industrial production, fixed-asset investment, and retail sales. To further compound investor worries about the data, the National Bureau of Statistics in China stated that it had suspended releasing breakdowns of unemployment data and some other labour-market indicators, including the youth unemployment rate, which stood at 21.3% in June. China’ economic woes could be largely explained by a deflationary shock from reversals from their two most important cyclical drivers – property and exports. As such, the positive momentum growth from the reopening at the beginning of this year has largely fizzled out. On the property side, sales have rapidly deteriorated since April as developer defaults have crushed the pent-up demand of flats since the beginning of this year. Meanwhile, exporters had to cut prices to cope with weaker demand, intensifying the deflationary dynamics at play.

The weakness over the past few months has prompted obvious changes in government policy, leading to a surprising interest rate cut earlier in June. At the same time, the Politburo has increasingly signalled more willingness to support demand across consumption, investment, and property. On the fiscal side, whilst policy was contractionary earlier in the year as there were expectations of a strong reopening, the public spending will likely flip into growth territory for the rest of the year. In addition, we continue to see property policies continue to relax including the Guangzhou local government which became the first tier-one city in China to reduce downpayment requirements and mortgage rates by effectively expanding the definition of first-time homebuyers. This does make a meaningful property-policy shift from earlier in the year, as local governments in first-tier cities pledged to do more to support their local housing markets even though they have yet to take any concrete action.

Despite the increased urgency from the government towards the property sector, it still has not prevented further credit deterioration in the sector. Last month, the property market had one of its highest profile credit events, after bellwether developer Country Garden Holdings (COGARD) faced concerns of a liquidity crisis – as reflected by its failure to make coupon payments for its due 7 August USD bonds. COGARD bonds fell to new lows at single-digit levels, even though the company did have until 5th September – the end of a 30-day grace period – to cure the coupon or face default. To the surprise of investors, COGARD managed to cure the USD coupon at the eleventh hour and paid another coupon for a MYR denominated bonds within the same week. However, the positive reaction from the COGARD complex remained muted as investors believe it is likely heading towards an offshore debt restructuring regardless of the company’s willingness to pay in the short term. Meanwhile, contagion risk had spread to other private sector developers which had relatively high cash prices for their bonds. For example, the China Vanke complex fell by 4 – 9 points, sparked by a local court’s order to freeze subsidiary Xiamen Vanke’s shares in 14 project companies. The share freeze arose from a dispute with a partner which had been ongoing since 2021 over a project in Xiamen City. Whilst the bonds did recover marginally after the announcement of the freeze lift, sentiment stayed largely weak for most the week.

The weak sentiment in property was exacerbated by the negative headlines surrounding trust financing company Zhongrong Trust and its second largest shareholder, Zhongzhi Group which together are one of China’s largest asset managers with AuM of over RMB 1 trillion. Three companies for which Zhongrong is a trustee, reported missed payments on trust products totalling RMB 153 million. Whilst the size of the missed payments is small, the timing of the headlines coincided with the fallout from Country Garden – which prompted many queries from investors about the linkages between trust financing and the property sector being a scope for contagion. It is important to highlight that property-linked investments account for only about 7-8% of total trust assets in China according to the China Trustee Association. Nevertheless, the market did see the Chinese Big 4 state owned distressed asset management companies’ bonds trade weaker given their perceived exposure to the real estate sector in China. However, it appeared that contagion risk was well contained last month as China’s National Financial Regulatory Administration promptly formed a task force to examine Zhongzhi’s trust arm, according to a recent Bloomberg article.

The negative sentiment towards Chinese developers has also spilled over marginally towards Hong Kong developer names with sizeable China exposures. In late August, New World Development (NWD) saw its bonds sell off after a Hong Kong blogger’s article was published alleging that an unnamed company controlled by a local Hong Kong big family was going to be in trouble due to high leverage and exposure to the Chinese property market. The blogger also alleged that the company had pledged at least three property projects for loans using a method that effectively disguises debt as equity. Although, the blog did not mention any company name, investors had speculated that it was New World Development based on suggestions from the project names. Even though, the company quickly came out to refute the allegations, it was clear the contagion had gradually spread to even the Hong Kong developer names. While we do not have significant exposure to either NWD or the Hong Kong property market in general, the fall in such a blue-chip name was still alarming for overall market confidence.

Away from China, Indian mining conglomerate Vedanta Resources was weak after the company informed credit investors that it had engaged Morrow Sodali to identify the holders of three of its USD bond tranches to ‘improve communications with the holders’. The move had limited impact on the bonds (down 3 points) as there were already rumours since mid-July that the company was mulling options including an exchange offer for its bonds.

As with the overall Asian high yield market, the JKC Asia Bond 2025 portfolio performance in August continued to be impacted by movements in the China property sector which dragged performance and offset stable gains across most other segments although it only accounts for approximately 10% of the fund’s AUM. On a brighter note, right at month end the Chinese government announced a series of new stimulus measures which appeared significantly more impactful than the piecemeal policy tweaks investors have become used to in the past two years. Of note was an announcement to drastically reduce many home purchase restriction policies in top tier cities, some of which have been in place for over a decade. This came too late to impact on our August performance, but it should provide some much-needed market uplift in the latter part of this year. Going forward we will eagerly wait to see the government’s plans to assist the rehabilitation of defaulted developers which, in our view, remains an obstacle to a full recovery of the sector. However, announcements of bond restructurings appear to be accelerating, which is a highly encouraging development.  

Despite this market reliance on policy support which is out of our control we maintain a proactive approach to our fund strategy including the management of distressed names. We continue to monitor all positions carefully and consistently assess the merits of holding or trimming exposures on a case-by-case basis with the aim of maximizing fund returns and liquidity.