Top Fund Says China Junk Bond Yield Premiums to Rise on Defaults

  • AA- bond yield premium over AAA may widen, says Soochow Dingli
  • Soochow Dingli ranks first of all bond funds tracked by Howbuy

China’s top bond fund said the premiums on onshore high-yield corporate notes may rise as the government permits more defaults.

The government may allow debt non-payments “in an orderly way,” Yang Qingding and Chen Chen, fund managers at Soochow Asset Management Co., said in an e-mail interview. Their Soochow Dingli Bond Fund has returned 16.5 percent in the past year, ranked No. 1 among all note funds tracked by research firm Howbuy. More defaults will remove price distortions and push up the extra yield on AA- rated securities over AAA debentures in the medium term, they said. Bonds with AA- ratings are considered junk in China. 

Mounting debt failures “will help better allocate resources and boost the bond market’s role in the supply-side reform,” wrote Yang and Chen. “This is going to be a big trend in the bond market.”

Investor demand for local junk notes has slumped after at least 10 firms missed onshore bond payments this year, already exceeding the tally for all of 2015. The yield premium of three-year AA- rated corporate securities over top-rated notes increased 10 basis points in May, after jumping the most this year in April, according to data compiled by Chinabond.

The People’s Bank of China appears to be preparing for a cash shortage by adding funds to the financial system. It increased the reverse repo offering in Tuesday’s open-market operations to the most since May 5. It also injected 40 billion yuan ($6 billion) via a treasury deposit auction on May 27.

“Liquidity will remain reasonably ample given that demand for social financing is weak and the economy is in the process of restructuring,” wrote Yang and Chen. “Seasonal liquidity shortages won’t have a lasting impact on the bond market.”

— With assistance by Judy Chen

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