Photographer: David Paul Morris/Bloomberg

Top Asia Junk Bond Funds All Bought China Builders After Default

  • Allianz, Value Partners, Aviva all see higher default rates
  • None of funds forecast doomsday scenario for China in 2016

The best-performing emerging Asia junk bond funds this year all navigated a landmark default to profit from China’s property debt. They see more opportunities as the nation prevents rising delinquencies from sparking a crisis.

Allianz Global Investors led with a 7.3 percent return through Dec. 24 this year, followed by Aviva Investors Global Services Ltd. with 5.8 percent and Value Partners Group Ltd. with 5.7 percent, according to data compiled by Bloomberg. All three held a higher proportion of notes from Chinese property firms than benchmark indexes, even after Kaisa Group Holdings Ltd. became the first Chinese builder to default on dollar notes in April.

Premier Li Keqiang reacted to the slump in the property market, which accounts for about one third of the economy, by relaxing rules on mortgages and allowing builders access to the domestic bond market for financing. A rally in Chinese developers led yields on Chinese dollar high-yield bonds to as low as 7.8 percent in October from over 12 percent in January, according to a Bank of America Merrill Lynch index. While all three funds expect credit fundamentals to worsen next year amid slower economic growth, they don’t see an alarming rise in default rates.

“Given the slower economic outlook, we naturally expect credit metrics of some issuers to deteriorate,” said Mark Tay, the manager of Allianz’s $26.3 million Dynamic Asian High Yield Bond fund. “However, we do not foresee a material rise in the default rate of Asian high-yield issuers, and a widening in credit spreads due to macro risk aversion thus presents us with a good opportunity to pick up bonds at much better value.”

China’s leaders signaled last week they will take steps to support growth, including widening the fiscal deficit and stimulating housing. A housing recovery spread in November, with new-home prices rising in 33 of 70 cities tracked by the government.

“The property sector was beaten down at the beginning of the year,” said Gordon Ip, who manages Value Partners’ Greater China High Yield Income Fund, which had $2.3 billion in assets as of Dec. 24. It increased China real estate holdings to 54 percent of holdings in the fund from 47 percent before the first quarter rout. “We saw a turnaround of the sector after rounds of targeted easing.”

Chinese developers and other Asian high-yield bonds have generated a total return of 4.2 percent this year, according to a Bank of America Merrill Lynch index. That compares with a 5.1 percent loss for U.S. junk notes.

Easing Boost

Allianz’s Dynamic Asian High Yield Bond fund allocated 51.6 percent of assets to the real estate sector as of Aug. 31.

Aviva Investors’ Asian High Yield Bond Fund had 41.3 percent of assets invested in the property sector as of Nov. 30. Tim Jagger, the manager of the $123.4 million fund, thinks China is still a good story because of policy easing.

“Within China, the homebuilding sector seems the most obvious place to be,” he said. Jagger prefers developers that have a diversified portfolio. Shanghai-based Shimao Property Holdings Ltd., Beijing-based Longfor Properties Co. and Guangdong-based Country Garden Holdings Co. are worth holding because of their potential to be upgraded to investment grade in the next few years, he said. All three are rated BB+ by Standard & Poor’s, the highest score for speculative-grade bonds.

Mounting Failures

More firms in China are struggling to repay debt amid the worst economic slowdown in a quarter century. Earlier this month, pig iron producer Sichuan Shengda Group Ltd. became at least the seventh Chinese firm to renege on local debt obligations this year.

In addition to Kaisa, two Chinese coal firms also reneged on their offshore obligations. Winsway Enterprises Holdings Ltd., the Chinese coking-coal importer, missed interest payment for the second time in October on a debenture due 2016. Hidili Industry International Development Ltd. didn’t repay dollar bonds due Nov. 4.

Value Partners’ fund generated much of its return by buying notes rated "single B" because they are less followed and require more credit analysis, Ip said. Jiangsu-based Future land Development Holdings’s 10.25 percent 2019 notes, rated B+ by Fitch Ratings and BB- by Standard & Poor’s, was the top holding, accounting for 2.2 percent of assets as of Nov. 30. The bonds rallied from 96 cents to 107.7 cents this year.

Hao Hong, chief China strategist at Bocom International Holdings Co. in Hong Kong, said a shortage of dollars after the Federal Reserve rate hike could lead to some sort of crisis somewhere in the world. The yuan has dropped 4.2 percent against the dollar this year.

“Key risks for next year for our fund will be worse-than-expected slowdown in China and a deepened concern over weakness of the yuan,” Ip of Value Partners said. “However, volatility will provide ample opportunities for the fund to take advantage of indiscriminate selling in a nervous market.”

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