Real estate and related industries make up more than a quarter of China’s economy, according to Moody’s estimates.
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Chinese real estate bonds were once key performance drivers for Asian junk bond funds, but real estate bond market share has fallen due to the country’s real estate debt crisis.
As a result, high-yield bond investors in Asia should prepare for lower yields, investment analysts told CNBC.
The market capitalization of these real estate bonds has fallen from an average of over 35% to around 15% in some Asian high-yield funds, as the debt crisis has depressed real estate bond prices, according to portfolio managers and analysts who spoke to CNBC.
Real estate bonds have traditionally made up the bulk of the Asian high yield universe. But as their market value has fallen, so has their share of the overall Asian junk bond market. As a result, fund managers have turned to other types of bonds to make up for these losses, and investors in these high-yield funds may not find the same type of return.
High-yield bonds, also known as junk bonds, are lower-quality debt securities that carry greater risks of default – and therefore higher interest rates to offset those risks.
“The share of real estate in China has fallen significantly,” said Carol Lye, associate portfolio manager at investment manager Brandywine Global. “With the supply of Chinese property bonds down almost 50% year-on-year, the market remains quite broken, with only selected, high-quality developers able to refinance.”
The drop was mainly due to a combination of falling bond supply and defaulting bonds exiting indices, according to financial research firm Morningstar.
“As a result, the importance of real estate in China in [the] The Asian credit universe is shrinking,” said Patrick Ge, research analyst at Morningstar.
Last December, the world’s most indebted property developer, China Evergrande, defaulted on its debt. The fallout from this crisis has spread to other companies in China’s real estate sector. Other developers showed signs of strain – some missed interest payments, while others defaulted on debt altogether.
Fund managers are looking to other areas to fill the void left by Chinese real estate, but analysts say these replacements are unlikely to offer better returns than their predecessors.
“Move to other sectors and countries [away from the very high yielding China property space] certainly reduces relative performance [to the index] in the portfolio,” said Elisabeth Colleran, Emerging Markets Debt Portfolio Manager at Loomis Sayles.
“However, managers need to think about what return can actually be achieved with the loss of a default,” she told CNBC.
In the past, funds that were more overweight in Chinese real estate bonds outperformed those with less weight in Chinese real estate bonds, Ge said — but that is no longer the case.
“It is unlikely to be the case in the future, at least in the short term, given the sector’s liquidity difficulties and its damaged reputation,” he said.
China’s massive real estate sector has come under pressure over the past year as Beijing has clamped down on developers’ heavy reliance on debt and soaring house prices.
Fill the void
As fund managers for Asian high-yield bonds pull their money out of Chinese ownership, the areas they are diversifying into include the renewable energy and metals sectors in India, according to Morningstar.
Some also see upside potential in real estate in Indonesia, which they expect to benefit from low mortgage rates and an extended government stimulus to support the Covid recovery, Ge said.
“With the supply from China declining, interest in Indonesian high yield has increased since the China housing crisis,” said Lye of Brandywine Global. “Indonesia has been relatively more stable as it benefits from raw materials, there is demand for housing and inflation has not gotten out of control.”
Asian high-yield portfolios in Southeast Asia are likely to be less risky for investors, as they have “relatively stable” credit quality and lower risk of default, according to a recent Moody’s report.
“Portfolio managers will need to rely on their bottom-up credit-selection abilities more than in the past to pick winners/survivors in this sector,” Morningstar’s Ge told CNBC. Bottom-up investing is an approach that focuses on the analysis of individual stocks, as opposed to macroeconomic factors.
Expanding into other sectors is a “healthy” development as it helps diversify investors’ portfolios, said Lye, who nevertheless cautioned that it comes with other risks.
China’s housing debt crisis has led to a drop in investor confidence in the ability of its developers to repay their debt, after they received a series of ratings downgrades.
Property companies there have also faced difficulties in attracting foreign funding – and that will keep liquidity and refinancing risks high, according to ratings agency Moody’s in a June report.
“The US dollar bond market remains largely closed to Asian markets [high yield] companies, raising concerns about companies’ ability to refinance their important upcoming maturities,” said Annalisa Dichiara, senior vice president at Moody’s.
Moody’s expects more Chinese property developers to default this year – half of the 50 names covered by the agency are under review for downgrading or have a negative outlook.
Data released earlier in June showed that the Chinese property market remains sluggish.
According to China’s National Bureau of Statistics, real estate investment in the first five months of this year fell 4% from the same period a year ago, despite the overall growth in investment in fixed assets.
Home prices in 70 Chinese cities remained subdued in May, up 0.1% from a year ago, according to analysis of official data from Goldman Sachs.
– CNBC’s Evelyn Cheng contributed to this report.