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RMB bond funds threatened by corporate defaults

The number of Chinese corporate defaults by issuer count and principal amount is likely to hit new highs this year, according to a recent Fitch report.

“Increasing refinancing pressure, greater government tolerance of defaults, sluggish manufacturing and industrial sector growth and weaker investor sentiment amid US-China trade tension re-escalation will likely push defaults rates higher,” said a Fitch Ratings spokeswoman.

The credit ratings agency expects 2019 defaults to hit a record high by issuer count and principal amount. Last year, 45 individual bonds with a value of RMB110.5 billion ($16bn) defaulted on their offshore or domestic issues, according the Fitch report published this week.

Twenty-two companies defaulted on 47 onshore bonds worth RMB31bn in the first four months of this year, while other issuers claim to have repaid bonds directly to bondholders instead of through clearing houses since March, which allowed them to hide late payments from publicity, according to Fitch.

“This means the actual number of corporate bond defaults may have been understated in recent months.”

Rival ratings agency Moody’s Investors Service has also warned about rising Chinese corporate defaults.

Meanwhile, the China government’s rescue of Baoshang Bank last week has raised worries about contagion within the Chinese financial sector amid a destabilising, unchecked build-up in bad debt, according to the Financial Times.

Renminbi-based fixed income funds posted negative returns in May, with the average return of funds authorised for sale to retail investors in Hong Kong and/or Singapore down 2.12%, according to FE Analytics.

Yet the best three-year returns (and year-to-date) returns have been earned by funds with wide exposure to corporate issuers – either denominated in US dollars or renminbi.

These include China bond funds managed by BEA Union Investment, Income Partners and Bank of China (Hong Kong).

In fact, the worst laggards over most periods are funds invested mainly in China government bonds or, especially, state-owned policy banks.

For instance, the contrast between one of the best performing funds over three years, the Income Partners Managed Volatility High Yield (16.49%), and one of the worst, the same manager’s RMB Bond Fund (-6.36%) is stark: the former invests almost entirely in private sector corporate bond, whereas the top five holdings of the latter are all China government entities, including a 35% weighting to China Development Bank, as at 30 April, according to the fund’s factsheet.

The poor performance of government (and state-linked) bonds is hardly encouraging for overseas investors compelled to enter the Chinese government bond market, following inclusion into the Bloomberg Barclays Global Aggregate Index last month.

Top performing RMB fixed interest funds

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

Part of the Mark Allen Group.