As a struggling Chinese real estate developer Evergrande Group (EVGPY) on the brink of what could become China’s largest debt restructuring, its effects are being felt in global markets.
The ICE BofA Asian Dollar High Yield Index, which tracks high yielding external corporate bonds of Asian companies, saw its average yield climb to 12% this week, from 7% at the start of the year, investors having fled the debt of Chinese companies, especially those involved in the real estate business.
Behind the market volatility lie fears that a default by the world’s most indebted company could send shockwaves through the Chinese economy and beyond. However, as lenders waited for a word from the company after failing to make a coupon payment of $ 83.5 million on September 23, several emerging market debt fund managers expressed more nuanced views at once. on Evergrande itself and on the likely fallout from a possible Evergrande default. .
Figure 1 shows the emerging market bond funds in Morningstar’s US fund database with the greatest exposure to Evergrande bonds.
Among emerging market fund managers whose strategies are rated by Morningstar, several had expressed doubts about Evergrande for some time.
Pimco’s global emerging market debt group, led by Pramol Dhawan, has grown increasingly suspicious over the past two years. Pimco Emerging Markets Bond (PEBIX), which has a Bronze Morningstar analyst rating, held a small stake (20 basis points) in Evergrande bonds in early 2020, but managers eliminated exposure to the company during the year as regulatory pressures were mounting. Nonetheless, the team is optimistic about the long-term outlook for China’s real estate sector, noting that housing demand remains robust. As other sellers rush to get rid of bonds from Chinese developers, Pimco executives say they are now looking for opportunities to invest in those with manageable debt and who are active in coastal housing markets and more stable urban areas in China.
T. Rowe Price’s emerging market debt team, meanwhile, only looked at debt when valuations became attractive. Lead portfolio manager Samy Muaddi manages the neutral-rated emerging market bond T. Rowe Price (PRXIX), who did not hold any debt from Evergrande at the start of 2020 but bought a modest amount at cheap valuations after the coronavirus-driven sale at the end of the first quarter of 2020. About six months later, the team went on to say sold off its remaining position, as analysts became cautious about Evergrande’s ability to maintain onshore funding.
TCW’s Emerging Markets Bond team started 2020 with a constructive view of Evergrande, but reduced positions throughout 2020 and the first half of 2021. TCW Emerging Markets Income, rated gold (TGEIX), which is co-managed by Penny Foley, David Robbins, Javier Segovia and Alex Stanojevic, held more than 1.0% of Evergrande’s portfolio in April 2020, but the team reduced that position to 0.48% at the end of 2020 and withdrew entirely by August 2021. At that point, the team was convinced Evergrande would likely need a full debt restructuring, noting that there was no clear precedent for a massive $ 304 billion restructuring that would involve hundreds of projects. TCW is waiting for Evergrande’s situation to stabilize before moving on to top-quality Chinese real estate developers who have sold by contagion.
Other bond fund managers have viewed Evergrande in a more positive light in recent months.
When Evergrande bond prices fell in August and September, BlackRock’s emerging market debt team, led by Sergio Trigo Paz, seized an opportunity. The group manages a number of global bond strategies for emerging markets, including BlackRock Emerging Markets Flexible Dynamic Bond (BEDIX). As Evergrande bonds hit troubled levels in mid-September, the group added the company’s debt to five of its strategies. The team argues that with Evergrande’s chances of a troubled exchange or crown corporation takeover considerable, the salvage value of the bonds is likely to exceed their current price by around 30 cents on the dollar.
London-based emerging market giant Ashmore Group remains one of the largest holders of Evergrande bonds, with $ 146 million held in multiple portfolios (according to portfolio data collected by Morningstar from June to August 2021). Ashmore Emerging Markets Short Duration Institutional (ESFIX) holds the largest individual stake in Evergrande (5.2% of assets at the end of June 2021). Country exposures in the team’s funds tend to deviate significantly from the index, and the team has historically hit troubled debts such as Argentina and Venezuela, with mixed success. Ashmore Emerging Markets Corporate (EMCIX) has also been one of the most volatile funds in its peer group, with a standard deviation almost double that of its index over the tenure of the team.
A rocky road for Chinese corporate bonds
With Evergrande’s stumbles reverberating noisily across the Chinese US dollar bond market, bond fund investors who had staked big on Chinese companies should feel some pain in the near term.
Figure 2 shows the global emerging market, corporate or multi-sector bond funds in our database with the largest exposures to Chinese non-government bonds.
While some headlines of the week may make investors want to hit the panic button, it’s important to remember that periods of market volatility are an integral part of investing. However, emerging market corporate bonds are particularly prone to idiosyncratic and geopolitical risks.
Investors should therefore favor funds with experienced and competent management teams following repeatable investment processes, including reasonable concentration limits for individual issuers and a robust risk control framework.