Bonds elude bashing by Trump victory

money-glitz | Daisy Wu 28 Nov 2016

Prices of corporate bonds in emerging markets dropped marginally after Donald Trump victory in the United States' presidential race, said Value Partners investment director Gordon Ip.

But other bond types - those with long maturities, new issuance, sovereign and quasi-sovereign debts in emerging markets -- generally crashed after the real-estate tycoon emerged as the clear winner of the US presidential race on November 8, said Ip.

In contrast, corporate bonds slipped by less than 1 to 2 percent between November 1 and 14.

In the week to November 11, just a few days after the US poll, about US$1.14 trillion (HK$8.84 trillion) was wiped off in the global bond market, according to Bank of America's Global Broad Market Index, as bond yields spiked on a general view that Trump's policies will boost spending and stoke inflation. Bond yields are inversely related to prices.

Trump's electoral victory also triggered capital flight from emerging markets to the US.

According to HSBC, US$5 billion worth of capital flowed out of emerging markets this month through November 21.

But the Asian-Pacific bond market remains the most resilient among its peers, with aggregate bond returns down 0.48 percent month-to-date, according to Bloomberg Barclays Indices.

Ip said the Asian bond market is different from those in other parts of the world as it enjoys strong demand from mainland investors. A weakening yuan is driving continuing capital outflows from China into US-denominated assets.

He said Chinese investors do not require high returns as they aim to maintain value, preferring the bond market. These investors start with corporate names that they are familiar with, and they are expanding to other Asian markets when they feel valuations of offshore issues of mainland entities are less attractive, Ip said.

There are only two ways to increase yield aside from short selling. Investors can either go down the credit curve or extend the duration of their bond holdings, he said.

Ip prefers buying bonds with lower credit to those with long tenors, which are exposed to a higher risk of an interest rate increase in the US as the Federal Reserve is on a path toward "rate normalization."

He said the Value Partners Greater China High Yield Income Fund he manages remains intact after Trump's electoral victory, as its net asset value rose 0.13 percent this month through November 24. The fund yielded an annualized return of 15.5 percent between January and October this year.

Ip, however, predicts the annual return next year to come down to 6-8 percent, while yield in the overall Asian junk bond market is expected at 4-6 percent.

The anticipated drop in return is due to limited capital appreciation opportunities and the uneven basis of comparison this year against next year, with 2016 being a high base.

The Fund has a mandate to allocate 70 percent of the money spent for investments in US dollar denominated Chinese bonds.

Ip said Chinese issuers tend to offer higher yields as investors see the market as riskier than other places. Understanding the mainland market is also a challenge.

The Fund uses a bottoms-up bond selection strategy, with no preference on markets and sectors. But it has a 51 percent exposure to the real estate sector, as 60 percent of Chinese junk bonds are issued by developers. Ip thinks that the Chinese government's cooling measures in its overheated property market are aimed at controlling the bubble instead of letting it burst. This will rein in capital expenditures of developers and thus, benefit bond investors.

He said the government would like the increase in home prices to be slightly higher than GDP growth, as the property market contributes up to one third of the country's growth.

Ip also cited a simple business model, comprising transparent land bids and sale prices and better recovery value in case of defaults as reasons why Value Partners likes developers. Among issuers of bonds that it holds, certain developers paid record prices for sites, said Ip, adding he does not take a negative view on land-king buying. The developer will benefit if it owns sites around the "land king".

The asset manager does not mind holding bonds that shall or have defaulted. "If the bond price drops to HK$20 after default and if you know you can recover HK$40, why can't you buy it?" said Ip.

Despite the yuan's depreciation, supply of Chinese US dollar- denominated junk bonds will not fall as many issuers have attended a refinancing cycle and offshore financing is easier, Ip said. Many issuers have hedged against their US loans, he added. Mainland stock exchanges have banned developers from issuing bonds to help cool the property market, forcing them to seek offshore financing.

The top 10 holdings of the Value Partners' Fund include bonds issued by Future Land Development (1030), Fantasia Holdings (1777), Oceanwide Holdings International 2015 Co. (5557) and Caifu Holdings, a subsidiary of Guangzhou R&F Properties (2777).

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