Licenced by SFC Type 1, 4 & 9 & MAS Capital Market Services
28 September 2021
“Will China Evergrande’s debt troubles pose a systemic risk ?”
“Risk-off sentiment spread across globally when China Evergrande raised fresh warnings of default risks as it struggled to raise funds to pay lenders and suppliers. Regulators and financial markets worried that the crisis could have spillover impacts across not just China’s banking system but also the whole supply chain.”
Figure 1: Evergrande’s stock and 2022 8.25% bond price (Source: Bloomberg)
Evergrande’s unusual silence about a dollar-bond interest payment that was due last Thursday has put a focus on what might happen during a 30-day grace period. The world’s most indebted developer has given no signs of having met the $83.5 million coupon payment, which has the grace period before any default could be declared. Evergrande’s EV unit has stopped paying staff and factory suppliers.
As the saga continues to unfold, investors are peeled to the on-going updates coming out from China. The world will be watching as China’s Central Bank vowed to ensure a “healthy property market” and protection of home buyers’ rights. Expectation of restructuring is on-going.
The People’s Bank of China (PBOC) continued to pump cash into the financial system amid concerns that contagion from Evergrande will affect market liquidity. It has injected a net 460 billion yuan ($71 billion) of short-term cash into the banking system in the past five working days, including 70 billion last Friday.
That being said, the situation remains very dynamic and fluid, investors should remain cautious and expect even more volatility towards the end of the year. We continue to recommend a more defensive and ultra-selective portfolio allocation, stock picking in certain sectors will be of utmost importance. Investors may also consider taking advantage of any volatility through the use of tactical trading strategies.
Fixed Income Overview:
Investors seem to be turning their attention to Treasury yields. We anticipate FED Funds rate to be kept 0% – 0.25%, with three to four rate hikes by the end of 2023. FOMC dots median at 1% by the end of 2023 based on 22 Sep 2021 meeting. The 10-yr US Treasury rebounded to 1.48% as of 28 Sept 2021 from 1.33% as of 14 Sept 2021 and is expected to be around 1.0% to 2.0% for the year of 2021. We do foresee a likelihood for Treasury yields to increase further towards to the end of this year, depending on the economic data and Fed’s policy stance.
The credit default swap (CDS)index for Asia ex-Japan Investment Grade rebounded to 88 as at 28 Sep 2021 from 66 as at 14 Sep 2021. Asia IG credit spread rebounded to 124 as at 28 Sep 2021 from 120 as at 14 Sep 2021.We expect IG bonds credit spreads to range bound over the coming months. Asia HY credit spread rebounded to 940 as at 28 Sep 2021 from 860 as at 14 Sep 2021. This is mainly due to the ongoing Evergrande saga. We expect sentiment in the HY bond market to remain relatively weak as there continues to be adverse news emerging out of the Chinese market.
Figure 2: CDS Asia ex-Japan Index 1-year Chart (Source: Bloomberg)
Highly leveraged HY bonds (B rated) may face refinancing/default risks – several onshore/offshore bonds have defaulted recently including bonds issued by Tsinghua Unigroup, China Fortune Land Development, Tus-Holdings Co. Ltd., Sichuan Languang Development and Sunshine 100 China Holdings. As the government support weaken, four Chinese AMCs (Huarong, Cinda, Orient & Great Wall) may be downgraded and their credit spreads may widen.
We caution investors holding marginal investment graded bonds (BBB-, Baa3) to be wary of downgrades. For investors with an investment grade bond portfolio mandate, we recommend bonds with BBB+ ratings or higher, and portfolio duration of 3.5 – 4 years.
We again recommend investors to stick to short dated high quality (BB Rated) High Yield bonds with a duration of less than 3 years and control their exposure to highly leveraged BB-rated bonds (Greenland, RiseSun) and all B-rated Chinese real estate bonds. Investors should be prepared to hold their bonds to maturity. Geographically, we are overweight Emerging Markets’ bonds (Investment Grade and High Yield with BB ratings excluding China) and neutral on Developed Markets’ and Chinese bonds.
Further, we recommend investors to match their exposure of high-beta bonds such as: CoCo Bonds, Perpetuals, and high yield bonds to their respective risk appetites. It is also recommended for investors to hold a more diversified fixed income portfolio or to reduce leverage of portfolios due to various uncertainties across sectors. We advise investors to dive deeper into the issuer’s stand-alone fundamentals to ensure the strength of the company.
We recommend investors to continue to monitor low beta bonds. For reference, the purchase yields for 3–5-year low beta IG bonds are at 1-2%, and 3-5-year low beta HY bonds are at 3-5%. Overall, we recommend a balanced and more diversified portfolio of high quality (BB rated) high yield bonds and short duration IG Bonds. Although the absolute returns in the fixed income market may be low, it is still advised to maintain a portion of the portfolio in fixed income given the heightened volatility of the markets.
Figure 3: S&P 500 index (Source: Bloomberg)
Figure 4: Fed Dot Plot (Source: Bloomberg)
The U.S market looked ripe for a pullback with rich valuations while investors continued to digest the change of tone from Fed’s Jerome Powell tapering stance. The Fed signaled it’ll probably begin cutting bond purchases in November and the dot plot revealed officials are now evenly split on whether to start tightening in 2022.
Jerome Powell said ending the stimulus program in the middle of next year is “likely to be appropriate,” while adding that doesn’t mean rate increases will follow immediately.
To further dampen market sentiment, the Evergrande default saga took center stage, engulfing any delta variant escalation and tapering backdrop.
With the U.S market rich valuation and tapering backdrop, we have shifted our positioning. Despite regulatory headwinds to continue to hover over the Greater Chinese markets, we see value is starting to emerge in select sectors in the Greater China market. Sectors such as Technology and consumer related stocks are of note. That being said, investors must remain very selective and target specific names within each sector. Regulatory risks continue to be a worry in the region, but we think that the worse is likely to be priced in to a certain extend.
Figure 5: Year-to-date chart comparing Dow Jones Index and Hang Seng Index (Source: Bloomberg)
Henceforth, geographically, we recommend a 40/60 exposure for the U.S vs Greater China markets. Investors should be prepared for a mid-long term investment horizon.
As the signs continue to point towards the FED beginning to taper its asset purchases towards the end of the year, we expect volatility to increase even further. The key focus will be on the magnitude and pace of the taper. We urge investors to stay constructive and selective in terms of stock selection and weigh their risk-and-reward. Volatility will persist, and investors should lean towards a more conservative portfolio.
Our investment strategy stays largely intact. We recommend sectors such as cybersecurity, consumer discretionary, select technology and healthcare.
It is important that investors adopt a well-diversified and defensive portfolio, reduce any over-exposure towards equities and raise some cash. In short, investors should employ a more back-to-basics stock selection approach and continue to adhere to company fundamentals and strict risk management principles (stop-loss mechanisms and/or appropriate portfolio hedging) to mitigate risks from market swings and uncertainties.
This material is provided for informational purposes only. It is not a recommendation or solicitation of any investment or investment strategy. There is no guarantee that any investment or strategy will achieve its objectives. Unless otherwise stated, all information contained in this document is from Raffles Assets Management (HK) Ltd. and/or Raffles Family Office Pte Ltd (Singapore) and is as of 28September2021. The views expressed regarding market and economic trends are those of the authors and are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets, or sectors will perform as expected. By acceptance of these materials, you agree that you shall use the information solely to evaluate your investment in this Raffles Assets Management (HK) Ltd and/or Raffles Family Office Pte Ltd (Singapore) sponsored investment opportunity and you shall keep the information confidential.
Derek Loh – Head of Equities
Mr. Derek Loh is the Head of Equities at Raffles Family Office. Derek has numerous years of work experience from top asset management firms and Banks – 13 Years on the Buy-side across 3 Major Cities in Hong Kong, Singapore and Tokyo. Derek demonstrates in-depth industrial knowledge and analysis, covering mostly listed equities.
Ex-Portfolio Manager for ACA Capital Group, managing a multi-billion dollar global fund for a world-renowned sovereign wealth fund and reputable institutional investors. Previous notable Investors serviced include Norges Bank (Norwegian Central Bank), Bill & Melinda Gates Foundation and Mubadala. Derek holds an Executive MBA from Kellogg School Of Management and HKUST. He is also a CPA.
Lawrence Chan – Head of Fixed Income
Mr. Lawrence Chan is Head of Fixed Income of Raffles, where he is responsible for credit and fixed income investments.
Mr. Chan has over 15 years of experience in the fixed income industry. Prior to joining Raffles, he was Chief Investment Officer (Fixed Income Investment Department) of Taiping Assets Management (HK) Co. Ltd. to manage China Taiping Group’s offshore bond investments and co-manage MPF & ORSO funds for China Life Trustees. His co-managed China Life Guaranteed Return Fund won various awards from Bloomberg Businessweek (2015-2017), BENCHMARK (2015) and MPF Ratings (2015-2016). He had worked for various financial institutions, including Taikang Asset Management (HK) Co. Ltd., Deutsche Bank AG (HK Branch) and Hong Kong Monetary Authority.
Mr. Chan graduated with a Master’s degree in Finance from The Chinese University of Hong Kong and a Bachelor’s degree in Accountancy (with First Class Honours) from City University of Hong Kong (formerly known as City Polytechnic of Hong Kong). He is a CFA charterholder, Hong Kong CPA, and a Fellow of the Association of Chartered Certified Accountants (“ACCA”).