China Bond Buyers Quiz Taxi Drivers to See If Credit GoodBloomberg News
Poor disclosure practices in China leave need for field trips
Without doing legwork, investors ‘may step on a land mine’
In China, taxi rides aren’t just a form of transportation any more. They’ve also become useful for bond buyers doing due diligence. Dining out at restaurants is also helpful.
It’s all part of a boom in field trips by market participants coming to grips with a new reality in China: the potential for bond defaults. After decades when authorities effectively provided blanket assistance to keep troubled companies from going under, the Communist leadership’s focus on shuttering unproductive assets has upended the market.
A total of 45 onshore corporate bonds have defaulted since the start of last year, a surge from the eight recorded in 2014 and 2015 -- which themselves were the first since the market was established in the 1980s. While China has the world’s third-largest bond market, corporate financial transparency can be limited, forcing investors to get creative.
“If you just sit in the office, you would never know if an issuer has actually closed business,” said Xu Hua, a money manager and deputy head of research at Colight Asset Management in Shanghai. “When you go to the local places, be sure to have a chat with taxi drivers or restaurant customers after talking to the issuer -- ask them if they have friends working for the company. Has their friends’ pay been cut or raised this year? Has the company delayed paying salaries? What’s the local reputation?”
Recent incidents have showcased concerns about corporate governance and disclosure standards. The onshore bonds of two China Hongqiao Group Ltd. units slumped in March after the world’s biggest aluminum maker said full-year results may be delayed because of issues raised by its auditor. Bondholders of China Shanshui Cement Group Ltd. are still trying to recoup most of their money -- at one point the company said it couldn’t repay interest without a company seal.
“A lot of information about Chinese bond issuers isn’t disclosed; when they do, the quality of the information may be unreliable,” said Christopher Lee, Hong Kong-based managing director of corporate ratings at S&P Global Ratings.
Onshore market players are finding themselves traveling a lot more nowadays, across the world’s third-largest nation by geography. Xu at Colight, one of the top-rated private fund firms for fixed-income strategy by the official China Securities Journal last year, says his team has even ventured as far as Xinjiang -- a central Asian region 4,000 kilometers from Shanghai.
Xu said a field trip at the end of 2015 had helped his firm avoid investing in a risky company with apparently normal cash flow. They learned from local people that its coal mine had halted production and the firm had delayed paying employee salaries.
“Chinese companies only disclose the parts they want you to see,” said Xu. “If you just stay at the companies for one day or half a day, you won’t be able to see the real situation.”
The research team at Bosera Asset Management Co., China’s fourth-biggest money manager, has ramped up its on-site visits since the start of last year, to an annual pace of 70 to 80 currently, according to Chen Zhixin, head of fixed income research in Shenzhen. Their counterparts at the country’s largest fund manager, Tianhong Asset Management Co., have roughly doubled their on-site visits compared with a couple years ago.
“Given the many explosions of credit risk in 2016 and this year,” more road trips became critical, said Cheng Shixiang, a fixed-income researcher in Beijing at Tianhong, which oversees 1.5 trillion yuan ($223 billion) of assets. His team’s grass-roots research includes talking to locals about the bond issuers.
“If it’s a property company, we would interview people around its projects and ask nearby real-estate brokers if the projects have been involved in any financial dispute,” Cheng said. He and his colleagues also gather intelligence from local banks.
That’s a contrast with fund managers abroad, who have an abundance of information readily available about companies selling bonds. In addition to publications like quarterly earnings reports, they can tap the research of investment bank analysts, along with articles in the media and specialty trade publications. And issuers themselves are typically active in communicating with investors, says Wang Ying, a senior director in Shanghai at Fitch Ratings.
“Few Chinese issuers initiate such communication with bondholders,” she said. “It’s more toilsome to be a Chinese bond investor -- but without those toils, you may step on a land mine and end up with a loss of money.”
— With assistance by Judy Chen