Real estate and related industries account for more than a quarter of the Chinese economy, according to Moody’s estimates.
CFOTO | Publishing in the future | Getty Images
Chinese real estate bonds were once major performance drivers of junk bond funds in Asia, but the market share of real estate bonds has fallen as a result of the country’s real estate debt crisis.
As a result, high-yield bond investors in Asia should prepare for lower returns, investment analysts tell CNBC.
The market value of these real estate bonds has fallen from an average of more than 35% to about 15% within some high-yield funds in Asia as the debt crisis has driven down mortgage prices, according to portfolio managers and analysts who spoke to CNBC.
Equity bonds have traditionally made up the bulk of the high-yield world of Asia. But as its market value has fallen, its share in the total junk bond market in Asia has also shrunk. Thus, fund managers have turned to other types of bonds to offset those losses, and investors in these high-yield funds may never be able to find the same kind of returns again.
High-yield bonds, also known as junk bonds, are non-investment debt securities that carry a greater risk of default – and therefore higher interest rates to compensate for that risk.
“The share of Chinese real estate has fallen significantly,” said Carol Lai, associate portfolio manager at Brandywine Global Investments. “With the supply of Chinese real estate bonds down nearly 50% year over year, the market remains largely broken with only selected high-quality developers able to refinance.”
The drop is mainly due to a combination of lower bond supply and a dip in distressed bonds from indexes, according to financial research firm Morningstar.
“As a result, the importance of Chinese real estate in [the] The Asian credit world is shrinking, said Patrick Gee, research analyst at Morningstar.
Last December, China Evergrande, the world’s largest real estate developer, defaulted on its debts. The repercussions of that crisis spread to other companies in the real estate sector in China. Other developers showed signs of stress – some defaulted on interest payments, others completely defaulted.
Fund managers are turning to other areas to fill the gap left by Chinese real estate, but analysts say these alternatives are unlikely to offer better returns than their predecessors.
Shift to other sectors and countries [away from the very high yielding China property space] Definitely reduces the relative return [to the index] “In the portfolio,” said Elizabeth Colleran, emerging market debt portfolio manager at Loomis Sales.
“However, managers need to think about the return that can actually be achieved with the loss from defaulting,” she told CNBC.
In the past, Jie said, funds that weighed more heavily on Chinese property bonds outperformed those that weighed less on Chinese property bonds — but that is not the case anymore.
“It is unlikely that this will be the case going forward, at least in the short term in light of the sector’s ongoing liquidity struggles and reputational damage,” he said.
China’s huge real estate sector came under pressure last year as Beijing stressed developers’ heavy reliance on debt and house prices soared.
bridging the gap
As high-yield bond fund managers in Asia move their money out of Chinese real estate, the areas in which they are diversifying include India’s renewable energy and mineral sectors, according to Morningstar.
Some also see a potential upside in real estate in Indonesia, which expects to take advantage of lower mortgage rates and extended government stimulus to support the COVID recovery, according to J.
“With the supply from China declining, the interest in high yield in Indonesia since the real estate crisis in China has increased,” said Lai of Brandywine Global. “Indonesia has been relatively more stable because it benefits from basic commodities, there is demand for housing and inflation has not gotten out of control.”
Asia’s high-yield portfolios in Southeast Asia are likely to be less risky for investors, as they have “relatively stable” credit quality and lower default risk, according to a recent Moody’s report.
“Portfolio managers will have to rely on their ability to choose bottom-up credit more than they have in the past to pick winners/survivors in this sector,” J Morningstar told CNBC. Bottom-up investing is an approach that focuses on analyzing individual stocks, as opposed to macroeconomic factors.
Going into other sectors is a “healthy” development as it helps diversify investor portfolios, Lai said, but cautioned nonetheless that it comes with other risks.
The way forward for developers
China’s real estate debt crisis has dented investor confidence in its developers’ ability to repay their debts, after they received a series of ratings downgrades.
Real estate companies there also face challenges in attracting funding from abroad — and that will keep liquidity and refinancing risks high, rating agency Moody’s said in a June report.
“The US dollar bond market remains largely closed to Asia [high yield] Companies, said Annalisa DeSchiara, senior vice president at Moody’s, are raising concerns about companies’ ability to refinance their large upcoming maturities.
Moody’s expects more real estate developers in China to default this year – half of the 50 names covered by the agency are under review for a rating downgrade, or have a negative outlook.
Data released earlier in June showed that China’s real estate market remains weak.
Real estate investment during the first five months of this year fell 4% compared to the same period last year, despite the overall growth in investment in fixed assets, according to China’s National Bureau of Statistics.
Real estate prices in 70 Chinese cities remained low in May, up 0.1% from a year ago, according to Goldman Sachs analysis of official data.
CNBC’s Evelyn Cheng contributed to this report.