Outlook for Greater China high yield bond market
Value Partners Greater China high yield income strategy (“the Strategy”) has delivered a year-to-date (YTD) return of +15.9% as of the end of December 2016. In the eventful month of November, the strategy only slid 0.2% marginally (the J.P. Morgan Asia Credit Index China index dropped 1.7%) while the global bond market lost over a trillion dollar after the unexpected outcome of the US Presidential election on 8 November. In view of the Strategy’s outperformance and the outlook for 2017, we have invited Gordon Ip, Investment Director of Value Partners, to share his thoughts with us.
1. How did you and your team manage to deliver an outperformance in 2016, especially in November?
We set out our allocation early in the year to go down the credit curve as we believed investors’ yield-chasing behavior would continue and lead to more abundant opportunities in the lower credit space. This, however, required more intensive due diligence and credit work which differentiated us from the competition. In Asian credit markets, sovereign and quasi-sovereign issues, being the most sensitive to US Treasury moves and fund flows, underperformed massively in November. During the month, high yield issues outperformed high grade ones while corporate names outperformed sovereign bonds. Our portfolio avoided all casualty areas.
2. How has market sentiment changed post US Presidential election and the latest round of rate hikes by the US Federal Reserve (the Fed)?
The astounding victory of Donald Trump to become the next US President spooked global markets by surprise. Trump’s victory may fundamentally alter the market landscape in the years to come. However, we think it is too early to form a view and formulate any strategy around Trump’s administration. In our view, Trump has a tall order to fill on his campaign scenario for the markets.
Meanwhile, the sharp increase in inflation expectation (because of Trump’s pro-growth policy) and the widely expected rate hike by the Fed in mid-December sent US Treasury yield to the highest level since Nov 2014. We agree with market consensus and think that US rate hikes will be gradual and measured with two to three additional ones in 2017. Nevertheless, there are still other structural issues out there globally, such as Europe and Japan are still in deflation, and Trump can’t change it alone.
3. Do you see any major risks or mitigating factors in 2017?
General perception by the public towards Trump’s fiscal stimulus and the Fed’s hawkish stance are likely to send yields higher in the US at least for the short term. To a certain extent, this may induce fund flows out of Emerging Markets into the US and lighten liquidity in Asia.
However, Asia is still relatively more attractive as stability is good for the bond market. With political uncertainty in the Eurozone a risk to watch out for in 2017, political situation in Asia remains relatively more stable than the western world. At the same time, China fundamentals have clearly bottomed out since early 2016 and further worsening seems unlikely. In fact, mainland Chinese investors are seeking dollar assets with higher return than bank deposits. The abundant liquidity from mainland China to Asian bond market serves as a good technical factor. Amid the prevailing yield-chasing behavior, this will provide support to Asian credit markets although they are likely not considered cheap.
4. Are you concerned about the Asian credit cycle?
There will be occasional volatility in 2017 but large-scale corporate default, which is the biggest risk to the credit portfolio, is highly unlikely. While we expect RMB depreciation against the strong USD will continue in 2017, we don’t foresee a heightened default rate of Chinese offshore debt as these issuers have the ability to roll over their debt. During the last boom cycle between 2004 and 2007, Asian credits delivered positive returns as rising rates mean better economic fundamentals for corporations. Even if there is a pullback in the market, there will still be money chasing those bonds. Yet, you have to adjust your return expectations for 2017.
5. China high yield bonds have significant exposure to China’s property market, what is your view on the sector especially after the recent tightening?
The recent restrictive measures on China’s property market are positive to the sector as it is not healthy for the property bubble to grow too big. Nonetheless, it would be unwise for the government to let the sector go down substantially given the fact that it is contributing a third of the country’s economic growth.
6. What is your investment strategy for 2017?
It is still too early to adopt a new strategy to respond to the US Presidential election and the sharp rise in yields. Any change in Trump’s policy could result in very different scenarios for the markets. To hedge against a potential inflationary pressure in 2017, the strategy will maintain positions in energy, materials and industrial sectors.
Meanwhile, it will be much more challenging to deliver double digit return again in 2017 due to the high base from 2016. We will be expecting to generate returns from alpha than beta meaning that we will need to do a lot more ground work to discover opportunities from special situations, stressed and distressed credits which tend to be under-researched.
The views expressed are the views of Value Partners Hong Kong Limited only and are subject to change based on market and other conditions. The information provided does not constitute investment advice and it should not be relied on as such. All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. This material contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Investors should note that investment involves risk. This commentary has not been reviewed by the Securities and Futures Commission. Issuer: Value Partners Hong Kong Limited.