Chinese sovereign bonds to outperform corporate debt, says Investec
Chinese government bonds should outperform corporate debt in both the onshore and offshore markets this year, which may in the process mean a widening of credit spreads, according to Investec Asset Management emerging market fixed income portfolio manager Wilfred Wee.
The South African firm which manages assets worth more than 150 billion pounds (US$209 billion) has been buying onshore Chinese sovereign debt toward year-end after yields have risen to attractive levels due to the deleveraging efforts by the People’s Bank of China.
Upcoming headwinds to the nation’s economic growth also means inflation will be capped, limiting room for further rises in yields while Chinese bonds will generally become a core asset class for international investors as China opens up, Wee said.
In contrast, China’s corporate debt market did not experience any losses despite tighter liquidity conditions on the mainland, Wee said.
The yield on lower-risk, high grade AA-rated 3-year notes rose by 120 basis points (bps) last year to the current levels of about 5.8 per cent. But the yield on riskier, lower grade A-rated issues of the same maturity rose 97 bps to 10.5 per cent. In the process, the yield spread between the two types of credit paper narrowed 24 bps to 469 bps.
“As deleveraging continues in China and corporates face challenges, we will likely see wider credit spreads to reflect higher default rates which is inevitable over the next couple of years,” Wee said. “We are not that negative but at the end of the day, we are more conservatively positioned given that spreads across all asset classes are toward a tight level.”
Investec has reduced its holdings of Chinese corporate offshore US-dollar denominated bonds because of expectations for US interest rates to gradually grind higher.
Some mining companies, coal producers and heavy industry producers that were struggling a few years ago have rebounded along with crude oil and other industrial commodity prices, which increased their revenues, Wee said.
By gradually lifting money market rates and bond yields last year, China is signalling higher costs of funding that should lead to a repricing of risk across various fixed income segments and to more efficient allocation of capital, away from unproductive, zombie firms, he said.
“Deleveraging in China is not about a reduction of absolute levels of debt but to address companies that are not really productive,” Wee said.
China’s tight corporate spreads show that debt for these risky companies have not been repriced correctly. Those debts yields still have room to go higher, Wee said.
“If you are able to reallocate credit to companies with positive cash flow over time, then you will get deleveraging because these companies will be able to pay down debt,” Wee said.