Investors with an interest in Chinese fixed income have to track a wide range of domestic and international developments. These include global macroeconomic trends that could impact the Chinese economy, the quality of domestic issuers, as well as differing dynamics of onshore and offshore debt.

    These were some of the topics discussed by a group of Chinese investors who formed a panel at HSBC’s latest Credit Conference. Taken together, their views formed a detailed outlook on the market trends that matter the most to investors in China’s debt markets.

    They started by discussing a US phenomenon that potentially affect credit markets across the world – namely, the recent inversion of the US Treasuries yield curve. This is widely seen to be a warning sign that the US economy could enter a recession, but among the panel’s investors it is an indicator that a low-rate environment is here to stay.

    “The inverted yield curve creates a conundrum for credit investors,” said Ray Wepener, Executive Director at Haitong Securities, as the common strategies in a low-rate environment all have drawbacks. Increasing duration for example, adds risk without an attractive premium to make it worthwhile. Adding leverage to the portfolio is not so attractive, due to comparatively high front-end funding rates. And going down the credit curve is not attractive as the inverted curve suggests that a recession is on the way.

    He said that people are approaching the situation by selectively going down the curve, without taking too much duration risk, with a focus on high-yield names.

    For some investors however, leverage is currently an attractive option to increase returns from low rates, and this is due to stability in the costs to fund a position.

    “When I did leverage two years ago, I had to worry about whether my day-to-day funding could be done at the same rate,” said Jin Zhou, Assistant General Manager, Head of Fixed Income and Asset Management, Orient Finance Holdings (HK). At present, he said, the funding rate can be locked down until maturity, which means that the main concern is no longer the amount of leverage available but how comfortable the investor is with the underlying credit.

    Diversification – inside and outside China

    The rise of the renminbi as an investment currency, along with the substantial amount of Chinese debt denominated in US dollars, means that Chinese investors have to factor currency considerations into their strategy. The recent downward move of the renminbi against the US dollar is an example of the kind of development that could affect returns.

    Some Chinese investors are therefore broadening their portfolios to reduce their exposure to assets in their home market. “The experience of diversification increasingly confirms our determination to diversify,” said Vivien Gui, Head of Fixed Income, Great Wall Pan Asia International Co. She said that in her active portfolio, China accounts for less than half of the holdings.

    She described how when she started her portfolio two years ago, it was at a peak for Chinese high-yield in terms of valuation. The move to diversify into credit from other emerging markets was therefore driven by the conditions of the market. So in 2017, when the market for Chinese credit was weak, she was able to find liquidity in other emerging markets. And going forward the strategy should continue to be valuable if Chinese markets exhibit volatility over the coming years.

    But instead of just thinking of diversification as a move away from Chinese debt, it can also be achieved within the universe of Chinese credit – something that another panellist said was impossible a decade ago when Chinese issuers consisted of a handful of financial companies and state-owned companies. Nowadays China is the largest player in the Asian credit space with onshore and offshore bonds issued by a diverse range of institutions – such as SOEs, local government financing vehicles (LGFV), as well as private issuers in the property and technology sectors.

    Avoiding credit events

    The need to avoid credit events is another reason for investors to carefully position themselves within the Chinese credit space, as a wave of defaults has shown weaknesses in some parts of the market. The panel was in general agreement that defaults would be an ongoing occurrence among China’s bonds, but that certain areas would be hit harder than others.

    The main factor to look out for, said the panel, was the possibility of systemic risk. The reasoning is that the market believes the Chinese government will not allow a company to miss payments on its bond if it would result in broad economic and financial consequences.

    But more generally, the panel was confident that China’s financial system is stable, with enough liquidity in the economy and state support to avoid the emergence of systemic risk. Furthermore, there are ongoing reforms that should also help reduce broad economic risks – such as deleveraging and the management of property prices.

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