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China real estate bonds were once key leverage for Asian junk bonds, but the market share of real estate bonds has declined as a result of the country’s real estate debt crisis.
As a result, high-yield bond investors in Asia need to prepare for lower yields, investment analysts told CNBC.
The capitalization of these real estate bonds fell from an average of more than 35% to about 15% in some high-yield Asian funds as the debt crisis reduced real estate bond prices, according to portfolio managers and analysts who spoke to CNBC.
Ownership bonds have traditionally been the largest part of the high-yield universe in Asia. But as their market value declined, their share of the overall Asian junk bond market also shrank. As a result, fund managers have turned to other types of bonds to cover these losses, and investors in these high-yield funds may not be able to find the same kind of returns again.
High-yield bonds, also known as junk bonds, are non-investment bonds that carry higher risk of default – and therefore higher interest rates to offset those risks.
“The share of Chinese real estate has fallen sharply,” said Carol Lye, associate portfolio manager at Brandywine Global Investment Management. “With the supply of real estate bonds in China reduced by almost 50% year-on-year, the market remains fairly fragmented with only select high-quality developers who can refinance.”
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The decline is mainly due to a combination of lower bond yields and bankrupt bonds that fell outside the index, according to financial research firm Morningstar. “As a result, the importance of real estate in China [the] “The Asian credit universe is shrinking,” said Patrick Ge, an analyst at Morningstar. Last December, the world’s most indebted real estate developer, China Evergrande, defaulted. The effects of that crisis spread to other Chinese real estate companies. Other developers showed signs of pressure – some lost interest payments, while others defaulted altogether. Fund managers are turning to other sectors to fill the gap left by real estate in China, but analysts say these replacements are unlikely to offer better returns than their predecessors. “Moving to other sectors and countries [away from the very high yielding China property space] definitely reduces the relative performance [to the index] in the portfolio, “said Elisabeth Colleran, head of emerging market debt portfolio at Loomis Sayles. “However, managers need to think about what return can really be achieved by losing a bankruptcy,” he told CNBC. With lower supply from China, interest in Indonesia High Performance has grown since the real estate crisis in China. Carol Lye Associate Portfolio Manager, Brandywine Global In the past, the assets that weighed heavily on China’s real estate bonds outperformed those that weighed less on Chinese real estate bonds, Ge said – but that is no longer the case. “This is unlikely to happen in the future, at least in the short term, given the industry’s ongoing liquidity struggles and wounded reputation,” he said. China’s huge real estate sector came under pressure last year as Beijing reduced developers’ high debt dependence and rising house prices.
Filling the gap
As Asian high-yield bond fund managers transfer their money from real estate to China, the areas in which they differ include the renewable energy and metals sectors in India, according to Morningstar. Some also see a possible rise in Indonesia real estate, which they expect to benefit from lower mortgage rates and extended government incentives to support Covid’s recovery, Ge said. “With lower supply from China, interest in Indonesia High Performance has increased since the real estate crisis in China,” said Lye of Brandywine Global. “Indonesia has been relatively more stable as it benefits from commodities, there is demand for housing and inflation has not gone out of control.” Asia’s high-yield portfolios in Southeast Asia are likely to be less risky for investors, as they have “relatively stable” credit quality and a lower risk of default, according to a recent Moody’s report. “Portfolio managers will have to rely on bottom-up credit options to select winners / survivors in this area,” Morningstar’s Ge told CNBC. Bottom-up investing is an approach that focuses on the analysis of individual stocks, as opposed to macroeconomic factors. Moving to other sectors is a “healthy” development, as it helps diversify investor portfolios, said Lye, who warned, however, that there are other risks.
The road ahead for developers
China’s real estate debt crisis has resulted in a sharp drop in investor confidence in its developers’ ability to repay their debt after receiving a series of rating downgrades. Real estate companies there also faced challenges in attracting foreign funding – and that will keep liquidity and refinancing risks high, according to Moody’s in a June report. “The US dollar bond market remains largely closed to Asia [high yield] companies, expressing concern about the ability of companies to refinance large upcoming maturities, “said Annalisa Dichiara, senior vice president of Moody’s. Moody’s expects more Chinese real estate developers to default – half of the 50 names covered by the agency are under scrutiny or have a negative outlook. Data released earlier in June showed that China’s real estate market remains sluggish. Real estate investment in the first five months of this year fell 4% from the same period last year, despite an overall increase in investment in fixed assets, according to the National Bureau of Statistics of China. Property prices in 70 Chinese cities remained muted in May, up 0.1% from a year earlier, according to an analysis by official Goldman Sachs data. – CNBC’s Evelyn Cheng contributed to this report.
