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Highest Junk Yields Spur Best Of BRICs Performance: China Credit
Perspective | 14 September 2012

Chinese companies’ US dollar-denominated junk bonds have gone from worst to first among the biggest developing economies as global monetary easing fuels demand for the highest-yielding assets.

The securities handed investors a 25 percent gain this year through 7 September following a 13 percent loss in 2011, according to Bank of America Merrill Lynch data. Brazilian companies’ non-investment-grade US dollar debt returned 8.6 percent this year, Russia’s 16 percent and India’s 15 percent. Only the Chinese paper offers an average yield of more than 10 percent, which compares with a 0.92 percent rate for US Treasuries.

Eastspring Investments, Baring Asset Management and Mirae Asset Global Investments said they are keeping their bets on China’s debt as the central bank is likely to ease monetary policy further to combat the slowest economic growth in three years.

“If people see any significant slowdown or contraction, Asian central banks have the capacity to take monetary action and governments have the fiscal ammunition,” said Sean Chang, the Hong Kong-based head of Asian debt at Baring, which oversaw US$47 billion at the end of June. “This should support the search for yield. We do have some China property and oil companies.”

‘Hunting For Yield’
Debt due January 2015 sold by Evergrande Real Estate Group, China’s biggest developer by sales volume, has the largest weighting in Bank of America’s Chinese high-yield index, and gained 3.9 percent this month. Citic Pacific’s bonds due January 2018 have the second-biggest share and returned 0.6 percent. The benchmark, which includes 56 bonds with a combined face value of US$23.8 billion, climbed 1.7 percent to a record this month as 32 of its members traded at or above par.

“Investors are hunting for yield and buying Chinese real estate bonds,” said Kim Jin Ha, Seoul-based head of global fixed-income at Mirae Asset, which oversees about US$55 billion. “Earnings in the first half came in in line with market forecasts, proving false concerns earlier in the year that they would suffer amid a cash squeeze.”

Property Prices
New-home prices rose in 49 of the 70 cities tracked by the government in July, the highest proportion in 14 months, as interest rates were cut for the second time this year and incentives for first-time buyers bolstered demand. The statistics bureau reported increases for 25 cities in June.

Prices rose for a third month in August, adding to evidence of a rebound in market sentiment as the government signalled property curbs are working to stabilise prices, according to SouFun Holdings, owner of the country’s biggest real estate website, said on 3 September.

Still, President Hu Jintao said on 8 September China’s economy is facing “notable downward pressure” even as the government approves a slew of road and rail projects to spur growth. Gross domestic product grew 7.6 percent in the second quarter, the smallest advance since the first quarter of 2009.

A government report released on 10 September showed China’s imports unexpectedly fell 2.6 percent in August from a year earlier. The data underscore risks the economy will slow, undermining support for the ruling Communist Party before a once-in-a-decade leadership transition due later this year.

The People’s Bank of China lowered borrowing costs in June and July, the first cuts since 2008, and relaxed lenders’ reserve requirements three times since November to support the economy.

Onshore Yields
The yield on the government’s 10-year local-currency bonds rose four basis points, or 0.04 percentage point, to 3.46 percent on 10 September, the highest level since 14 May, according to data compiled by Bloomberg. The yuan strengthened 0.09 percent to 6.3376 per US dollar in Shanghai, extending a six-week rally, according to the China Foreign Exchange Trade System.

The cost to protect against losses on China’s sovereign bonds fell the week ended 7 September to the lowest level since July 2011. Five-year credit-default swaps insuring against non-payment dropped 61 basis points this year to 86 in New York on 7 September, according to data provider CMA. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent if a government fails to adhere to debt agreements.

Morgan Stanley cut its recommendation on Asian high-yield debt to “Accumulate” from “Buy” this month, saying key drivers including credit conditions in China are no longer improving. The dominance of property developers among Chinese issuers leaves global investors with little scope to diversify risk, according to Royal London Asset Management.

The average yield on Chinese junk US dollar debt was 10.3 percent on 7 September, down from 16 percent at the end of 2011, Bank of America data show. In the US, the rate is 6.6 percent.

Tough Proposition
“The new normal for the high-yield market has become 7 to 8 percent, which means many companies have a reason to stay leveraged,” said Azhar Hussain, the London-based global head of high-yield debt at Royal London, which manages US$78 billion. “The fears of being at an informational disadvantage in a market where recovery prospects are low and where there is little diversification in the sector makes it a tough investment proposition.”

China and Hong Kong-based companies with non-investment-grade ratings have raised US$4.1 billion in US dollar bond issues this year, accounting for 1.7 percent of global offerings, according to data compiled by Bloomberg. They sold US$10.5 billion, accounting for 3.9 percent of issuance, in the same period of 2011.

“Chinese high-yield bonds have outperformed partly due to the lack of new supply,” said Leong Wai Mei, assistant director of Asian credit research at Eastspring, which manages about US$86 billion in Asia as a unit of Prudential. “Valuations are about fair. We are cautious, but also mindful of the fact that this low interest-rate environment is still prevailing and investors are still attracted to yields.”

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