Credit Hedge Fund Shorting China Junk Bonds as Risks Mount

  • Double Haven hedge fund favors Australian, Japanese bonds
  • Firm sees downside risks for Indonesia, Malaysia, Philippines

Double Haven Capital (Hong Kong), a credit hedge-fund firm that profited last year as most of the industry struggled to make money, is betting against Chinese high-yield bonds as many investors are seeing risks mount in this part of the market.

Chinese high-yield bonds have gotten expensive, and heavily indebted issuers throughout Asia need to refinance existing loans, Darryl Flint, chief investment officer of the Hong Kong-based hedge fund, wrote in a newsletter to investors. Double Haven, which has traded more than $10.7 billion of public and private Asian securities since 2011, said a wave of refinancing activity could also amplify price volatility.

Double Haven is joining peers such as BFAM Partners (Hong Kong) and Value Partners Group Ltd. in taking a bearish view on Chinese junk bonds this year after such securities helped regional fixed-income managers return nearly eight-fold the average Asian hedge fund gain in 2016. Double Haven did even better, climbing 8.7 percent last year as the average Asia hedge fund rose 0.8 percent for the worst annual performance since 2011, according to preliminary data from Eurekahedge in Singapore.

“Given 2017 is likely to be dominated by events similar or extensions to those of 2016, the strategy is to enter the year in a defensive way,” Flint wrote in the commentary in late December. “We are net short China high-yield beta, given the yield multiple to investment grade is at all time tights."

Commodity Rebound

High-yield bonds in Asia returned 11.2 percent last year, more than double that of 2015, according to JPMorgan Chase & Co. indexes. Credit managers focused on the region benefited last year from the rebound of bonds from commodity-related issuers and emerging markets such as Indonesia.

This year, they’re bracing for a bumpy ride on expectations of interest rate hikes and a stronger dollar as Donald Trump takes over as U.S. president this month. Price fluctuations could also rise on political risks as Trump has promised to slap punitive tariffs on imports from China and back out of the Trans-Pacific Partnership trade pact.

Return on China high-yield bonds may drop to 6 percent to 8 percent this year, down from double-digit gains in 2016, Gordon Ip, manager of the $2.1 billion Greater China High-Yield Fund at Hong Kong-based Value Partners Group Ltd., said in October.

BFAM, the more than $2 billion hedge-fund firm led by Benjamin Fuchs, has also been taking profits on bonds issued by Chinese property companies that it owned, the former Lehman Brothers Holding Inc. trader said in an interview last month. Increases in the London Interbank Offered Rate, or Libor, which determines the borrowing rate investors use to finance such trades, are making them less attractive.

Many Risks

"The companies themselves are fine but the underlying securities have a lot of risks, because short-term Libor funding rates are going up and yields have come in," said Fuchs, whose fund returned an estimated 17.5 percent last year. If the Libor rate moves significantly higher, those bonds will come under pressure, he said.

Fuchs has made money from Chinese property junk bonds he bought during the sell-offs in the last two years, including those of Kaisa Group Holdings Ltd., the first Chinese property developer to default on dollar debt.

Double Haven favors Asia speculative-grade dollar bonds where issuers are involved in corporate events such as mergers, debt buy-backs and asset sales, according to Flint. The firm also likes dollar-denominated investment-grade debt from Chinese issuers in the utility, technology and financial industries and remains bullish on Asian investment-grade issuers in the oil, coal, gold, copper, iron ore and steel industries, Flint wrote. Double Haven has bought developed Asian bonds from Australia and Japan.

Across Asia, high-yield issuers are more than twice as leveraged as their investment-grade peers, Flint noted, citing JPMorgan Chase & Co. data. Chinese developers account for about 26 percent of the $10.7 billion in regional high-yield dollar-denominated bonds maturing in 2017, the single biggest group, according to data compiled by Bloomberg. About $18.5 billion of junk bonds from Asia will come due in 2018, more than triple last year’s amount.

Double Haven is also bearish on export-reliant South Korea and markets most likely to be hit by the sell-off of emerging-market bonds by international investors, including Indonesia, Malaysia and the Philippines.

Unlike China, Hong Kong and South Korea, which are more driven by domestic investors, the three Southeast Asian countries are more dependent on demand from international investors, Flint wrote. In addition, some bond exchange-traded funds invest heavily in debt from countries including Indonesia, Malaysia and the Philippines relative to their weightings in Asian markets, making the bonds vulnerable to investor outflows during market sell-offs such as the one seen after the U.S. presidential election, he said.

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