Outflows From China Rout Seek Unlikely Haven in High-Yield Debt

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Shanghai-based offshore fund manager Wu Xiangjun’s phone has been ringing off the hook since the yuan’s devaluation two weeks ago.

He says his customers want to know all they can about Chinese high-yield corporate dollar notes as they flee a domestic stock rout and seek diversification in case yuan declines accelerate. By contrast, global funds are trimming exposure to Chinese debt, increasing the yield on Country Garden Holdings Co.’s five-year U.S. currency bonds almost 1 percentage point in two weeks to 7.23 percent Tuesday, before the central bank cut interest rates for the fifth time since November.

“The yuan’s depreciation has made offshore dollar bonds more attractive to Chinese investors,” said Wu, who manages $96 million of funds focusing on overseas investments at Guotai Asset Management Co. “Low onshore bond yields encourage investors to look offshore for investment opportunities.”

The devaluation of China’s currency is encouraging investors to head abroad to protect their wealth, threatening to fuel further losses and outflows. Chinese companies face as much as $15 billion in extra costs for servicing foreign debt after the yuan slid 3.2 percent this month, according to calculations based on Bloomberg data. That’s adding to risks in a market already scarred by defaults of private-sector firms such as developer Kaisa Group Holdings Ltd. and coal trader Winsway Enterprises Holdings Ltd. this year.

High-Yield Debt

A high-yield Asian dollar bond index of Chinese issuers declined 3 percent in the past week, paring this year’s return to 4.3 percent, according to Bank of America Merrill Lynch. That compares with a weekly drop of 1.3 percent in a Bloomberg global high-yield dollar note gauge. Credit-default swaps protecting Chinese sovereign securities against non-payment for five years climbed to 119 basis points Tuesday, the highest since 2013, according to CMA data.

“Concerns over China will probably continue weighing on Chinese names’ offshore notes in the short-term,” said Steve Wang, Hong Kong-based head of fixed-income research at BOCI Securities Ltd. “High grades in short tenors will probably be the choice.”

The central bank shocked global markets with a 1.9 percent devaluation of the yuan on Aug. 11. The onshore currency fell 0.17 percent to 6.4234 a dollar as of 10:49 a.m. in Shanghai as the PBOC lowered its one-year deposit rate by 25 basis points to 1.75 percent. The yuan traded offshore slid more than 4 percent in two weeks to 6.4991 in Hong Kong Wednesday. The five-year yuan sovereign bond yield has fallen to 3.20 percent from 4.46 percent at the end of 2013 as the central bank slashed benchmark rates.

Weakening Expectation

“Wealthy Chinese now have more of an incentive to invest in non-yuan assets,” said Norman Chan, an investment director at NAB Private Wealth Advisory in Hong Kong. “In the long run, Chinese investors will diversify their currency exposure as the one-way yuan appreciation trend seems to have ended.”

Some Chinese agencies have begun to assume in their research that the yuan will weaken to 7 against the greenback by the end of the year, and to 8 by end-2016, according to people familiar with the matter who asked not to be identified because the studies haven’t been made public.

Extra Incentive

“In the old days, Chinese buying into dollar bonds was a pure yield play,” said Ben Sy, Hong Kong-based head of Asia fixed income, currencies and commodities at JPMorgan Chase & Co.’s private banking unit. “Now there is an extra incentive, which is to put money on the stronger dollar.”

Average daily sales of products under the Qualified Domestic Institutional Investors program, which allows Chinese investors to access overseas capital markets, doubled in the past two weeks from a month earlier, according to data from Howbuy Investment Management Co., an online mutual fund researcher and sales platform.

HFT Investment Management Co. will start a QDII bond fund as early as September, investing mainly in dollar-denominated bonds issued by Chinese companies in the offshore market, according to a person familiar with the matter. The fund will focus on notes with maturities of two to three years, with controllable credit risks and relatively high yields.

China has granted $89.99 billion in QDII quotas as of July 29. The latest step in capital-account opening was taken on May 22, when Chinese and Hong regulators gave the green light to a cross-border sale of bond, stock and other funds from July 1 with an initial quota of 300 billion yuan ($47 billion) in each direction. That came six months after a link between the Shanghai and Hong Kong stock markets started.

“In the short-term, pessimism is dominating market sentiment,” said Chen Yongqiang, a Beijing-based fund manager at China Asset Management Co., which has obtained $3.5 billion in QDII quotas. “When investors start to realize that the yuan’s strengthening has come to an end, and there may be even further depreciation ahead, they will probably add their allocation to overseas assets.”

— With assistance by Helen Sun, Judy Chen, and Lianting Tu

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