Pimco on Defensive Favors Utilities as Fitch Warns: China Credit
Pacific Investment Management Co.’s top debt picks are utility and energy companies that will benefit as China shifts to a consumer-driven economy, while indebted companies tied to the old export-led model suffer.
“We put our highest conviction in utility and energy sectors,” Raja Mukherji, Hong Kong-based head of Asian credit research at Pimco, manager of the world’s biggest bond fund, said in an e-mail interview on April 12. A shortage of energy resources and undeveloped distribution networks for consumers “creates opportunities if we can invest in the future winners early,” he said.
Utility and energy bonds gained 0.7 percent and 0.8 percent this year through April 18, the second- and third-worst performers among 12 Chinese sectors tracked by Bank of America Corp. That compares with a 2.6 percent return for real-estate bonds and an average of 2 percent for all dollar-denominated Chinese debt. Energy bonds handed investors a 37.4 percent return, topping an index average of 24 percent during China’s economic slowdown from April 2010 to September 2012.
Fitch Ratings Ltd. cut China’s sovereign ranking this month and Moody’s Investors Service lowered its outlook to stable from positive, citing risks from rising debt loads and the potential impact on the economy. LDK Solar Ltd. failed to fully pay notes last week after rival solar panel producer Suntech Power Holdings Co. defaulted on $541 million of bonds on March 15.
Economic growth is slowing amid a crackdown on lending for property speculation and unprofitable infrastructure projects. A government report showed last week gross domestic product increased 7.7 percent last quarter from a year ago, falling short of the 8 percent median forecast in a Bloomberg survey.
So-called trust loans jumped 320 percent from a year earlier to a record 431 billion yuan ($70 billion) in March as borrowers tried to get around curbs on bank funding, central bank data show. Former Finance Minister Xiang Huaicheng said April 6 that local governments’ combined debt may have exceeded 20 trillion yuan.
China’s 10-year sovereign bond yield fell nine basis points this month to 3.45 percent as investors sought safety in government notes. The spread on Chinese dollar-denominated securities over Treasuries widened 71 basis points to 367 basis points in the first three months of the year, ending a five- quarter narrowing run that saw a decline of 551 basis points in the period, according to the JPMorgan Corporate EMBI China Blended Spread index. The gap was 368 basis points today.
“We are likely to see a reining in of expansionary credit policies and a consequent fading in the strength of the economic recovery,” Mukherji said. “China’s economic leadership is cognizant of the risks of continuing policies dependent up on investment and perpetual debt creation.”
Pimco last year predicted China’s economy would expand 6.5 percent to 7 percent in the 12 months to September 2013, “the new normal with Chinese characteristics.” Banks including Goldman Sachs Group Inc., JPMorgan Chase & Co., Westpac Banking Corp. and Nomura Holdings Inc. last week trimmed their growth forecasts for 2013 to as low as 7.5 percent.
The slowdown complicates challenges for Premier Li Keqiang as he seeks to switch the economy’s engine of growth to consumer spending from exports and investments. Investors should avoid companies with high leverage and business models suited to the old system, Pimco said in a February report.
“In credit, the key is to stay defensive in an environment where the absolute compensation for credit risk in terms of spreads has compressed dramatically,” Mukherji said.
Fitch said April 9 its decision to lower the local-currency debt rating to match the international rank of A+ was based on the lack of transparency in the increased borrowing of localities. While central government debt is low, total government liabilities, when combined with regional debt, amount to 49 percent of GDP, a level in line with its rating peers, said Andrew Colquhoun, Fitch’s Hong Kong-based head of Asia- Pacific Sovereigns.
“So public finance is not a weakness, but neither are they a standout strength,” Colquhoun said in an interview last week. “The kind of risks we highlighted in our research do seem to be chiming with people.”
The cost of insuring China’s debt against non-payment climbed three basis points last week to 72, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market.
Even so, Pimco’s co-head of emerging markets portfolio management Ramin Toloui said on April 18 that he favors yuan assets traded in Hong Kong because of steady returns and low volatility.
“It’s a good investment in offshore renminbi because you get paid a 2 percent yield,” Singapore-based Toloui said in an interview. “If you adjust that 2 percent yield by the very low volatility, it looks even better.”
The yuan rose 0.5 percent this month to 6.1807 per dollar in Shanghai, and touched a 19-year high of 6.1723 on April 17. Three-month implied volatility, a measure of expected moves in the exchange rate, is 1.87 percent for the yuan in Hong Kong.
Pimco’s Emerging Asia Bond Fund (PEABEUI) returned 2.5 percent in 2013, bringing gains in the past year to 12 percent and beating 73 percent of its global peers, data compiled by Bloomberg show. Pimco favors major state-owned oil companies in Asia as governments are motivated to support this sector to sustain economic growth, Mukherji said, while not disclosing which bonds it holds in its fund.
The yield on the 2017 dollar notes sold by China National Petroleum Corp., the nation’s largest energy producer, fell five basis points this month to 1.77 percent today, having reached an all-time low of 1.71 percent on March 4.
“We expect Chinese state oil and gas companies to pursue more overseas acquisitions, and with government support,” Mukherji said. “We expect the companies to exhibit faster growth versus domestic gross domestic product and tap the bond markets to fund their long-term investment plans.”
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