Even Record Bond Defaults Can’t Stop China Yield Hunters’ Buying

  • Junk bond yield premium over treasuries drops to 2-year low
  • ‘Some funds are chasing flawed assets,’ Fullgoal’s Ye says

Even an unprecedented number of bond defaults haven’t stopped Chinese yield-hunting investors from buying onshore junk notes, driving borrowing costs to the lowest level in more than two years.

Seven-year corporate debt with AA- ratings, considered junk level in China, had a yield premium of 341 basis points over similar-maturity government notes, the lowest level since December 2013, according to Chinabond data. The 22 basis point decline this month was the biggest since May 2015. That’s even as 17 publicly issued notes have defaulted in the onshore market so far this year, compared with seven for the whole of 2015.

The credit market rout in April is a distant memory for Chinese yield hunters, who are following global investors’ flood into corporate bonds after treasury yields from Japan to Germany dropped below zero. Ping An Securities Co. estimated that wealth management product funds that Chinese banks authorize securities houses to park in the debt market may double to 5 trillion yuan ($749 billion) at the end of this year from about 2 trillion yuan in 2015.

“The inflows of a lot of funds from banks’ wealth management products into the bond market has increased demand for bonds with relatively high yields,” said Ye Sheng, an investment manager and head of fixed income research at Fullgoal Fund Management Co., which oversees 168 billion yuan of assets. “Some capital is chasing flawed assets under pressure to generate returns.”

The average target return for new six to 12-month wealth management products offered by city commercial banks was 4.36 percent in June, according to PY Standard. Those offered by rural lenders have an expected yield of 4.31 percent, said the Chengdu-based research firm. One-year AAA rated company notes yield 2.83 percent on average.

“Securities houses that are authorized to manage wealth management products are struggling to achieve the target returns,” said Shi Lei, the head of fixed income research at Ping An Securities Co. in Beijing. “Investors’ tolerance of risks is rising.”

Shi said the high-yield bond premium will decline further because investors believe the central bank will keep ample cash in the financial system to support the economy. The seven-day repurchase rate, a gauge of interbank funding availability, was 2.39 percent this month on average, compared with 2.43 percent in April and 2.60 percent a year earlier.

The yield on AA- rated Anyang Iron & Steel Inc.’s 2019 bond dropped 46 basis points this month to 8.16 percent, while that on Xining Special Steel Co.’s 2020 note declined 58 basis points to 7.12 percent, according to exchange data.

For a story on local governments meddling with loan decisions, click here.

“Investors must be very careful in selecting safe high-yield issuers,” said Shi. “Those industries with low concentration ratios and more state-owned companies will probably cut capacity more slowly.”

Corporate bond defaults dropped to zero in July, from one in June and five in May, amid signs that local governments are helping companies in financial trouble.

Fullgoal’s Ye said he prefers higher-rated bonds because they are less likely to be affected by credit events. The yield premium of seven-year AA- rated company notes over AAA bond narrowed 10 basis points in July to 274 basis points, set for the biggest decline since March 2014, according to Chinabond data.

The chasing of high-yield assets “is understandable in the short term,” said Ye. “But in the long run it may not be a good choice.”

— With assistance by Judy Chen

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