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How to invest beyond covid-19
In these days of covid-19, buyers are plunging their hard-earned cash snapping up boxes of face masks and loo rolls. In terms of yield, however, they provide little comfort.
20 Feb 2020 | Daniel Yu
Desmond How
Desmond How
In these days of covid-19, buyers are plunging their hard-earned cash snapping up boxes of face masks and loo rolls. In terms of return, however, they provide little comfort. Instead, one of the region’s top fixed income investors is suggesting doubling down on Chinese high-yield property bonds instead.
“In fact, if primary supply remains curtailed, Chinese property bonds whose valuation beats similarly-rated peers anywhere by a mile, would be a prized commodity even for the most transient crossover investors,” declares Desmond How, head of fixed income at GaoTeng Global Asset Management, an investment firm backed by Tencent Holdings and Hillhouse Capital.
How, ranked as an Astute Investor in G3 bonds for more than ten years by Asset Benchmark Research, a research firm specializing in rating fixed income investors, is unperturbed even with the recent outbreak of covid-19. “The property (sector) has a longer payable cycle than other sectors, which may struggle for working capital if the primary market is shut.”
In the case of Chinese property companies, he continues, “we have seen many developers pre-fund debt redemptions over the past few months”. He expects delays in land premium payments and construction payables, “as Chinese authorities are likely to step in with easing measures including removing restrictions on purchase and funding channels”.
How’s analysis is as much foresight as it is hindsight. “Fourth quarter 2018 was a horrible quarter for China property bonds as fear of default simmered through investors when [China’s] NDRC (National Development Reform Commission) stepped in to control US dollar issuance. On hindsight, it was the perfect spot for buy-on-dip as there was zero default on the sector in 2019 which became one of its best years, returning over 17% on average based on JPMorgan data.”
He believes that Chinese property remains the most undervalued investments. “The sector has a tremendous record of barely two default incidents over its 14 years of issuance history, incredibly low even by global standards. It is unbelievably good value for a single-B credit to yield over 10%, implying an overblown 35% default rate cumulative over three years.” 
In contrast, How takes a guarded view on Indian high yields suggesting that they are overvalued relative to their fundamentals and peers. “Admittedly, they have scarcity value due a legacy of RBI restriction against USD issuance above L+450 bp,” he explains. “With a potential fallout from shadow banking (as a change of scene away from China) however, we are getting less comfortable with some sectors that could be vulnerable to refinancing risk. Renewable energy is one that seems to have a long pipeline in the primary market and Andhra Pradesh’s ruling to cut tariffs may prove a further setback.”
In light of a possible coronavirus pandemic, he is similarly wary of sectors vulnerable to global supply chain disruption. “China has been both a major commodity importer and intermediary product supplier worldwide,” he adds.
Still, he reckons US$200 billion is now the baseline size of Asia’s G3 bond market given the recycling of funding needs from the existing issuers, “while new-kids-on-the-block are sprouting like mushrooms”. A possible coronavirus pandemic, he qualifies, may derail the new-issuance calendar, especially for debutant issuers who cannot travel for roadshows, and if protracted, could even dent general investor confidence.
Like many observers, he agrees that the primary market has grown lopsided towards Chinese issuance. In 2019, G3 new-issue activity from Chinese issuers account for 52.4% of the total market, raising over US$183 billion, according to Refinitiv, a data service provider.
But How cautions against getting overly excited. “There are always new Chinese shops, both buy- and sell-side, emerging every now and then,” he points out. “Chinese investors chasing after Chinese deals (not withstanding unrated local government financing vehicles) has become a trend and it is boomtown Charlie for debt syndicate managers who in turn chase after exclusive orders from newfound secret clientele. The risk is of course, when the orders are consolidated, uncovering those afterall-not-so-exclusive investors giving multiple shapes to different dealers, you get a fluffed book and the trade tanked in the secondary market.”
Similarly, he takes a more sanguine view on another recent phenomenon of ESG deals in Asia’s G3 market. “While a few global-scale investors may have vowed to make ESG bonds as predomination allocation to their portfolio in the near future, they will likely fail in Asia as issuers here being emerging economies still lag behind in particular, the environment criteria,” he points out.
Even as he remains constructive on high-yield Chinese property names, How is aware that the bull run in financial markets cannot go on indefinitely. “An inverted treasury yield curve has been a reliable leading indicator of recession in the US,” he points to the often-cited worry indicator among investors. “During the past six decades, eight out of nine times recessions occurred a few quarters after yield curve inversion.”
Citing data from Bloomberg, he shares that according to the Federal Reserve Bank of New York’s recession index (a prediction based on treasury spread), the probability of an US recession in the next 12 months has receded from a 38% high in August last year to currently 24%. For perspective, the index hovered below 10% normally but was at 25%, 21% and 39% at the start of 1990, 2001 and 2008 recessions. “While I don’t have the crystal ball to say whether 2020 would be the fateful year, I do reckon the question is more a matter of when than an if. Prospect of the coronavirus turning into a global pandemic certainly has increased such likelihood.”

    

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