Mostly tailwinds for China corporate bonds

Asset Class in Focus

China corporate bonds offer heady yields and the default rate last year was only 1%, but very high turnover is involved in Neuberger Berman’s China bond strategy.

Peter Ru, Neuberger Berman

“Ultimately, the authorities will continue to ‘encourage’ creditors and banks to come to the rescue of problem borrowers if they are important enough to local economies,” Peter Ru, senior portfolio manager of China fixed income at Neuberger Berman, told FSA in a recent interview.

Ru manages the NB onshore China bond fund in Shanghai with a team of five analysts, and as China fixed income strategy leader provides input for the China Bond Fund Ucit managed by Rob Drijkoningen and Gorky Urquieta from the firms’s EMD team. The Ucit has been awarded four stars by Morningstar and three crowns by FE Analytics.

The fund focuses on corporate debt rated AA – perhaps dubiously – by one of the three main mainland credit agencies and yielding 4% – 5%, compared with 3% for government bonds. It also buys low coupon convertible bonds which, in addition to the potential equity kicker, are put-able at par after two or three years and therefore offer downside protection.

In addition, the fund has 25% of its holdings in US dollar-denominated Chinese bonds issued offshore, such as real estate companies China Evergrande and Guangzhou R&F Properties, in order to gain extra yield and diversification.

The fund’s annual turnover ranges from 130% - 150%, which is necessary to protect the NAV from experiencing sharp declines

“We expect the renminbi to remain stable at around 6.7 to the dollar this year, so we haven’t hedged our exposure to either the renminbi or the dollar,” said Ru.

The fund’s annual turnover ranges from 130% – 150%, which Ru insists is necessary to protect the net asset value from experiencing sharp declines, and more than compensates for dealing costs.

“Accessing liquidity is the key to mitigating downside risks and to achieving returns. Because we can find liquidity, we are very active traders. A buy-hold strategy for bonds with maturity dates any longer than two years would result in too much volatility for the fund and discourage investors,” said Ru.

“Besides, bid-ask spreads are tight for the bonds we invest in and of course there are no commissions payable,” he added.

Nevertheless, the annualised volatility of the fund over the past three years is quite high at 4.42%, compared with 3.94% for the sector average, according to FE Analytics data.

Ru’s recommendations should be seen in the context of the admission of China bonds into a major index. Several money managers and strategists have described it as a watershed moment and are keen to attract investors into their China funds.

In January, Bloomberg said that it would include Chinese bonds from 1 April in its widely-tracked BBGA index after the Chinese authorities introduced enhancements to the market structure, such as the implementation of delivery versus payment settlement, the ability to allocate block trades across portfolios and clarification on tax collection policies.

Foreign flows into the $11trn China bond market (the third biggest in the world after the US and Japan) are likely to be higher than the figure implied by the 6.1% BBGA weighting, which will be reached in November 2020.

Ru points to the relatively high yields available and low correlation with other government bond markets.

He also believes that the biggest risk to all Chinese securities markets – equities as well as bonds – is a failure to resolve the Sino-US trade dispute.

“You simply don’t know what Donald Trump will do next,” he added.


The Neuberger Berman China Bond Fund vs Renminbi Bond Fund Sector Average

Source: FE Analytics. Three-year cumulative performance in US dollars.

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