China Distressed Bond Rookie Seeks 15% Returns as Defaults Surge

  • Genial Flow targets distressed returns of up to 15% a year
  • Returns can be similar to those on stocks, fund manager says

One of China’s first distressed bond investors says its steep learning curve since the first onshore default two years ago looks set to deliver rewards.

Genial Flow Asset Management Co. started watching China’s local junk bond market in 2014, when Shanghai Chaori Solar Energy Science & Technology Co. suffered its landmark non-payment. The five-year-old fund manager, which already has 20 billion yuan ($3 billion) of fixed-income assets, offers one product to risk-seeking investors that tracks a junk bond index and others that hold notes that have defaulted or have a high risk of non-payment. It’s targeting 8 percent to 15 percent returns for these funds.

“When a bond defaults, its price can go down to 30 to 40 yuan out of 100 yuan principal,” said Cheng Peng, the Beijing-based head of investments at Genial Flow, who declined to give details aside from saying he had bought several distressed notes at "low prices." “Return on that can be comparable to that in stocks if you follow through the whole restructuring process and get paid in the end.”

While several of China’s leading fund managers say they are staying clear of lower-rated onshore bonds, others including Sincetop Asset Management are generating annualized returns of more than 20 percent by buying troubled credits. Seventeen publicly traded bonds in China have defaulted so far this year amid the weakest growth in a quarter century, versus seven in 2015. While Premier Li Keqiang has vowed to let zombie companies die, local governments often stepped in to bail them out after non-payment.

Cheng, who worked at China Construction Bank Corp. trading bonds for nine years before joining the fund, cited as an example Yabang Investment Holding Group Co., a Chinese dye-and-paint maker whose bonds tumbled after it defaulted Feb. 9, before the company made the full payment in March. He didn’t hold those securities.

Note investors of Chaori Solar were paid in full within 10 months of non-payment. Chinacoal Group Shanxi Huayu Energy Co., a coal miner, repaid its defaulted bond completely in April.

For an insight on China default database, click here

Maturing Market

Offshore Chinese securities have also proved to have high recovery rates. Kaisa Group Holdings Ltd.’s restructuring plan approved in May helped its 2018 securities rally to around 82, from as low as 29.6 in January 2015, when it became the nation’s first developer to default on offshore debentures.

“It’s normal to invest in troubled bonds in the overseas market,” said He Xuanlai, a credit analyst at Commerzbank AG in Singapore. “A healthy bond market needs all types of investors.”

Some fund managers are steering clear. Wang Ming, chief operating officer at Shanghai Yaozhi Asset Management LLP, said his firm won’t buy distressed bonds.

“It’s uncertain whether you can get money back and it’s also uncertain how long it will take to get it back,” said Wang in Shanghai.

While the distressed bond market is relatively new in China, non-performing loans have been in existence for a long time and proven so lucrative that some of the world’s biggest investors are stepping in.

Cheng forecast the amount of Genial’s funds focused on high-yield bonds may rise five-fold to 1 billion yuan within five years. He said there will be more opportunities to invest in distressed debt as defaults rise this year. Some private funds, trust firms, brokerages or banks’ asset management units may be interested in such investments, he said. The yield premium of five-year AA- medium-term debt over top-rated corporate notes has climbed to the highest level in four years. The gap was 271 basis points Wednesday.

“Overseas statistics show that such investments’ returns are the highest when recession is almost over,” said Cheng. “It’s probably not the best time to buy but there is less competition in this area so it’s possible to find good opportunities.”

— With assistance by Yuling Yang, Lianting Tu, and Judy Chen

Before it's here, it's on the Bloomberg Terminal.