Real estate and related industries account for more than a quarter of China’s economy, according to Moody’s estimates.
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China’s real estate bonds were once key performance drivers for Asian junk funds, but the market share of real estate bonds has declined as a result of the country’s housing debt crisis.
As a result, high-yield bond investors in Asia should brace for lower returns, investment analysts told CNBC.
The market capitalization of these real estate bonds has fallen from an average of more than 35 percent to about 15 percent in some high-yield Asian funds as the debt crisis has depressed property bond prices, according to portfolio managers and analysts who spoke to CNBC.
Property bonds have traditionally formed the bulk of the high-yield universe in Asia. But as their market value fell, so did their share of the overall Asian scrap market. Consequently, fund managers have turned to other types of bonds to offset these losses, and investors in these high-yield funds may not be able to find the same kind of returns again.
High-yield bonds, also known as junk, are non-investment-grade debt securities that carry higher risks of default — and therefore higher interest rates to compensate for those risks.
“The share of real estate in China has declined significantly,” said Carol Lai, associate portfolio manager at investment manager Brandywine Global. “With China’s real estate bond supply shrinking by nearly 50% year-on-year, the market remains quite fractured, with only select high-quality developers able to refinance.”
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The drop was mainly due to a combination of lower bond supply and bond defaults from indexes, 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 effects of this crisis have spread to other firms in the property sector in China. Other developers showed signs of strain, with some missing interest payments while others defaulted on their debt altogether.
Fund managers are turning to other areas to fill the gap left by China’s real estate, but analysts say these replacements are unlikely to offer better returns than their predecessors.
“Redirecting to other sectors and countries [away from the very high yielding China property space] certainly reduces the relative yield [to the index] in the portfolio,” said Elizabeth Colleran, portfolio manager of debt markets at Loomis Sayles.
“However, managers need to think about what return can be achieved with the default loss,” she told CNBC.
With weaker supply from China, interest in high-yield Indonesian property has picked up since the Chinese property crisis.
Carol Lai
Associate Portfolio Manager, Brandywine Global
In the past, funds that had a higher weighting in Chinese property bonds outperformed those that had a lower weighting in Chinese property bonds, Ge said — but that’s no longer the case. .
“This is unlikely to be the case going forward, at least in the short term, given the sector’s ongoing liquidity struggles and damaged reputation,” he said.
China’s huge real estate sector has come under pressure in the past year as Beijing curbs developers’ high reliance on debt and soaring house prices.
Filling the gap
As high-yield bond fund managers in Asia move their money out of property in China, areas they are diversifying into include India’s renewable energy and metals sectors, according to Morningstar.
Some also see potential growth in Indonesia’s real estate, which expects to benefit from low mortgage rates and expanded government stimulus to support the Covid recovery, Ge said.
“With weaker supply from China, interest in Indonesian high-yield properties has picked up since the Chinese property crisis,” Brandywine Global’s Luga said. “Indonesia is relatively more stable as it benefits from raw materials, there is demand for housing and inflation is not out of control.”
Asian high-yield portfolios in Southeast Asia are likely to be less risky for investors because they have “relatively stable” credit quality and lower default risk, according to a recent Moody’s report.
“Portfolio managers will need to rely on their bottom-up credit selection capabilities more than in the past to pick the winners/survivors in this sector,” Morningstar’s Ge told CNBC. Bottom-up investing is an approach that focuses on analyzing individual stocks as opposed to macroeconomic factors.
Foraying into other sectors is a “healthy” development as it helps diversify investors’ portfolios, said Lai, who cautioned, however, that it comes with other risks.
Way ahead of the developers
China’s debt crisis has led to a sharp decline in investor confidence in the ability of property developers to repay their debt after receiving a wave of downgrades.
Real estate firms there also face challenges in attracting foreign financing — 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 Asians [high yield] companies, raising concerns about companies’ ability to refinance their large upcoming maturities,” said Annalisa DiChiara, senior vice president at Moody’s.
Moody’s expects more property developers in China to default this year – half of the 50 names the agency covers are under review for a downgrade or have a negative outlook.
Data released earlier in June showed that China’s real estate market remained weak.
Investment in real estate in the first five months of this year fell 4 percent from the same period last year, despite overall growth in investment in fixed assets, according to China’s National Bureau of Statistics.
Property prices in 70 Chinese cities remained low in May, up 0.1 percent from a year earlier, according to an analysis of official data by Goldman Sachs.
— CNBC’s Evelyn Cheng contributed to this report.
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