Time to Cut China Property Bonds at Standard Life; India Lures

  • China’s deleveraging efforts will widen property-bond spreads
  • Positive environment for credit likely to continue into 2018

Standard Life Aberdeen plc is reducing its holdings of dollar bonds sold by Chinese real-estate companies, expecting that Beijing’s efforts to reduce financial risk will hit the nation’s property prices.

Craig MacDonald, global head of fixed income at the company’s investment business, said he still holds some Chinese property credits, but sold the likes of Shimao Property Holdings Ltd. due to tight premiums over Treasuries. Property companies are responsible for about 23 percent of total dollar-debt from the country this year, bringing some $42 billion to market as domestic curbs made it more attractive to go offshore.

“The government is tightening up, it is looking at interest rates, it is looking at land prices, and therefore normally a tighter environment is bad for property companies,” MacDonald said in an interview this month in Tokyo.

“We aren’t saying there’s going to be a wave of defaults," he added. "But property prices will be more fragile in the next 12 months because of these tightening policies, and that will feed through into Chinese property spreads.”

Standard Life Aberdeen’s investment arm, operating under the brand Aberdeen Standard Investments, manages about $758 billion of assets.

The following are excerpts of a Q&A with MacDonald.

1. Concerns about China?

China has only started the deleveraging process, and that’s one of the issues.

They are doing things to re-balance the economy, which in the longer-term is good but it won’t be plain sailing. Deleveraging will be a source of volatility, but not a source of systemic risk for the global economy.

As you see Chinese local yields rise, you would expect more dollar-bond supply, because clearly dollar notes would begin to look cheap again for the Chinese companies.

2. Views on Indian credit?

We are still positive on Indian names such as ICICI Bank Ltd, which we think is a very strong bank.

Fundamentals for India continue to improve. Its deficits and interest rates are coming down and it is starting to re-capitalize its state-run banks. There are some good companies there, so you can buy now as long you are careful.

3. Outlook on global credit for 2018?

Our base case is still a reasonably solid global economy. Interest rates will go up slowly because there are limited signs of inflation and profit growth on average is still positive, but not as fast as this year.

The global economy is not too bad and balance sheets are slowly correcting. A strong U.S. banking system and an improving European banking system is probably a positive environment for credit.

The problem is that credit spreads have done well, so we are not expecting much tightening. It will be more of choosing the right names and getting some yield as opposed to lots of spread compression. In some areas such as the CCCs, you might see some decompression as people realize that they need to get more for owning CCC risk.

Investment grade and high yield won’t generate dramatic returns, and you have to be very careful with what you own.

4. Preferred strategies?

We still like European banks and subordinated bank risk. We think it is a good thing that a couple of the banks have been allowed to get into trouble, as it signals that as a whole the system is much stronger.

There are still some good European banks, where you are still being paid a nice amount for risk.

On emerging markets, there are still some individual names we like, such as Petroleos Mexicanos and Petroleo Brasileiro SA. We like some of the oil names.

5. Concerned about a 2018 market correction?

We would certainly expect some volatility, but we would be surprised to see a wholesale correction.

We are very underweight the really risky CCC stuff. In an environment of lower yields, there are certain areas where investors do seem to be overreaching just to get that extra yield, such as certain CCC names, the most subordinated parts of asset backed, or private small- and medium-sized lending.

We are concerned people are sometimes confusing illiquidity premiums with credit risk in those areas, but not concerned enough to think this is a systemic risk to the overall credit market. Some people will get burned in some of those areas in the next year or two.

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