“The [global] credit market is not considered cheap on an historical level. The way to get a breakthrough is to do things that others do not do,” said Gordon Ip, chief investment officer, speaking to media in Hong Kong this week. Ip focuses on the firm’s fixed income strategies.
He said his team goes to “the very bottom of the market” to search for opportunities because there are under-researched and even unheard of names that may prove to be attractive investments.
Jason Yan, a senior portfolio manager, used the example of China’s banking industry. “There is a diversified group of issuers among small and medium-sized Chinese banks. As these small-scale banks are usually first-time issuers, we believe they are mostly undervalued to a rather large extent.”
A wave of small bank issuance in China began in the second half of 2017 and he expects the trend will continue next year. Despite the compelling investment opportunity in this space, Yan has concerns about the small-scale lenders, especially those located in northeastern China.
He discovered that the majority of these provincial banks are lending to “micro-size” companies.
“The challenging side is the level of non-performing loans and bad debt due to the micro-size corporate clients, and a small quantity of banks falsifying their financial statements,” he said.
Meanwhile, bonds issued by the large-scale banks are less attractive because the expected yield tends to be lower than small-cap banks, according to Yan.
In general, China’s banking industry has seen “fundamental improvement” because of reduced non-performing loans, Yan said. The central bank’s cut in the reserve requirement ratio in October will also provide higher liquidity to banks, which will support refinancing of loans and generally cheaper funding.
Index inclusion
In March, Citi announced its EM and regional government bond indices will include China, following a similar move by Bloomberg Barclays in the same month. Citi’s announcement did not include China’s sovereign bonds in its widely-tracked World Government Bond Index (WGBI).
Ip said Citi’s decision to exclude the sovereign bonds may be based on unsatisfactory liquidity in the onshore bond market. A positive decision by the WGBI he believes will not be soon.
“Certainly, it would be a big statement if China’s bonds could make into WGBI. But, a liquidity issue persists in China’s bonds, which are traded in a ‘buy-and-hold’ market,” Ip said.
Although China is encouraging money to go in, the foreign fund managers who are now participating in the market merely want “a seat on the table” and are not primarily interested in returns, he added.
Moody’s Ivan Chung believes China bonds will gradually be tracked by more top bond indices, but he declined to give a timeframe. Market transparency and convenience in trading are the key to the inclusion in WGBI, Chung told FSA.
Chung is optimistic that the Bond Connect, launched in July, will prompt major indices to include China’s bonds.
Ip said Value Partners only participated in the Bond Connect scheme during the first week of launch. “We only bought paper with a maturity of at most 1.5 years. The issuers are all quality names. As of today, half of the commercial [issuance] has already reached maturity,” he said.
In 2018, Ip, who co-manages the Value Partners Greater China High Yield Income Fund with Yan, expects that the average yield of Asian bonds should be roughly 4%.
The Value Partners Greater China High Yield Income Fund versus the average of the Asia-Pacific fixed income sector.
