China High Yield Corporates: A Conversation With Ms. Ting Zhang, Portfolio Manager for the KCCB ETF
China has been systematically under-allocated to in global portfolios. This could be a mistake. In the current market environment, where yields on a 10-year US Treasury barely touch 0.90% and about one third of issued debt worldwide carries a negative yield, China is a bright spot. With 10-year treasury yields comfortably above 3%,1 it may be worth considering an exposure to China’s rate environment. While China investment grade and treasury bonds offer higher yields without moving too far up the risk spectrum, allocating to China high yield may potentially offer a greater reward for doing so compared to the US.
To help our clients gain a better understanding of China’s high yield bond market, we asked Ms. Ting Zhang to break down the market, its risks, and its potential benefits to global investors in a low rate world.
Would you please provide an overview of CCB Securities as a firm and your background as a portfolio manager?
CCB Securities is owned by China Construction Bank (Asia) (CCB), which is headquartered in Beijing but has offices worldwide. Established in 1954, CCB has grown to become the second largest bank in the world by assets. The bank has investment and retail banking divisions in China and around the world.
My name is Ting Zhang and I am a Fixed Income Portfolio Manager at CCB Securities. I have spent the past decade in the investment management industry and have long focused on fixed income investment. During my tenure, I have managed more than $15 Billion in multi-currency portfolios at CCB Asia and CCBS. In addition, I have extensive experience in Asset and Liability Management, Foreign Exchange, Money Market, and Interest Rates trading.
Would you please describe the bonds you in invest in?
KCCB tracks the Solactive USD China Corporate High Yield Bond Index, which is comprised of USD-denominated China corporate high yield bonds. The issuers in KCCB are well-known Chinese corporates mainly in the financial and real estate sectors. Example Issuers include Ronshine, Country Garden, ICBC Asia, and KWG Group Holdings. There are currently 52 holdings in the portfolio.
Would you please provide some color on one or more issuers in which the Fund invests?
A good example is KWG Group Holdings. The company is primarily involved in the real estate development businesses. KWG develops residential areas, hotels, and restaurants, among other types of projects. Meanwhile, the company also conducts education, long-term rental apartments, cultural tourism, and health businesses.
The company’s outlook is rated as “stable” by both Fitch and Moody’s. The default risk on its issued bonds is at 0.373% (IG10), which is relatively low compared to other China corporate bonds denominated in USD.
These bonds are issued in Hong Kong and denominated in US dollars. Does this diminish currency risk?
Because these bonds are denominated in US dollars, the currency risk is greatly diminished. However, it is not eliminated entirely as the issuers’ revenue streams are still denominated in Renminbi.
China is experiencing a V-shaped recovery post quarantine. Has the asset class reflected China’s economic recovery since March?
China’s recovery has been impressive, especially when compared to other major economies that are mired in the pandemic. China was the first major economy to return to growth following the damage caused by the coronavirus pandemic, with GDP growing by 3.2% in the second quarter compared to a year earlier after a record 6.8% contraction in the first quarter. The economy’s rebound has boosted the performance of the bonds in which KCCB invests.
In the US and Europe, rates have been near zero for a while and the Fed is suggesting that they will stay there for the long-term. Why is China’s rate environment so different from the rest of the world? Do you believe it will stay that way?
China maintains a higher GDP growth rate compared to the US and Europe due to differences in population, social structures, currency policies, and economic conditions. Because of these differences, we believe the bond market will retain its yield advantage over the long term.
China is currently the world’s largest emerging economy and has the largest consumer base globally powered by its growing middle class. Furthermore, the government continues to stimulate domestic demand and support the economy through its policy of “dual circulation,” maximizing self-sufficiency while remaining open for global trade.
What are the potential benefits of investing in Chinese High Yield bonds to global investors?
China has the largest USD-denominated bond market in Asia and China corporate bonds outperform other countries in Asia on a real yield basis. China’s historically high GDP growth rate means a stable credit market that offers attractive yields compared to other emerging market or developed market countries. The market, as defined by the fund, may offer higher yields and lower modified durations compared to many global high yield markets, not to mention the potential for comparatively lower default risk.
What are the risks embedded within the asset class? How did the bonds in KCCB fair during the Covid-19 liquidity crunch?
There are four main types of risk factors in typical fixed income portfolios: Macro, Market, Credit and Liquidity. We discussed macro-economic factors earlier. The market risk factors such as the level and trend of US interest rates would be the main drivers of total portfolio performance.
In addition, as a high yield fund, we take on credit risk. The credit rating of the underlying bonds depends on the company’s business. Their credit ratings will be impacted by news relevant to the market and their respective industries. Credit risk may also be impacted by the fact that a discrepancy sometimes develops between the ratings provided by Chinese ratings agencies and those provided by international ratings agencies, due to a difference in methodology and criteria. However, as the market matures, we can expect to see the gap between domestic and international credit ratings narrow, which may benefit the asset class.
The fund also takes on liquidity risk. When financial markets collapsed in March of this year, global liquidity dried up. This tends to cause a decrease in bond prices and thereby negatively impact the performance of the fund. For example, when the pandemic-induced liquidity crunch occurred, there was a dip in the performance of KCCB. But, when global liquidity recovered amidst better control of the disease, KCCB bounced back. The fund has recovered about 10% from its March low.2
As per our observation, there have been no equally extreme cases of a liquidity shock compared to that in March of 2020.
Which companies choose to issue bonds in Hong Kong and why?
Chinese companies need to file for approval with China’s National Development and Reform Commission (NDRS) before they can issue bonds in Hong Kong. The filing must specify the purpose of any proceeds from bond issuance. Since 2015, many qualified Chinese companies, mainly in the Financials and Real Estate sectors, have gone through the regulatory process required to issue bonds in Hong Kong.
Listing bonds in Hong Kong allows these companies to diversify their investor base by adding international investors, reduce their cost of capital by receiving ratings from international agencies, and promote their brands in the global market. For example, the cash raised by China’s property developers greatly helped them alleviate potential funding pressures from their fast-growing financing needs.
Which companies choose to issue bonds denominated in USD and why?
The US dollar ranks highest in international popularity, credibility, and convenience amongst major global currencies. Therefore, companies are likely to find more creditors by issuing dollar-denominated bonds than they would have by issuing renminbi-denominated bonds.
Companies that issue USD-denominated bonds are likely to have universally understood business models and believe that they will receive a decent credit rating from an international ratings agency.
In addition, due to the maturing cross-currency swap (CCS) market, the issuers could utilize CCS to lower their aggregate financing cost measured in domestic currency and, at times, take advantage of lower US dollar rates.
The KCCB ETF is distributed by SEI Investments Distribution Company (SIDCO), which is not affiliated with Krane Funds Advisors, LLC, the Investment Adviser for the Fund, or CCB Securities Ltd., the co-manager of the Fund.
- Data from Bloomberg as of 11/18/2020
- Data from Bloomberg as of 9/30/2020
- Gross Domestic Product (GDP): The total value of the goods and services exchanged within an economy over a period of time.
- Default Risk: The risk that an issuer will fail to meet its obligations to creditors by defaulting (missing a payment).
KCCB Issuers Mentioned
- Ronshine (RONXIN 8 3/4 10/25/2022, 2.11% of KCCB Net Assets as of 9/30/2020)
- Country Garden (COGARD 8 01/27/24, 2.16% of KCCB Net Assets as of 9/30/2020)
- ICBC Asia (ICBCAS 4 1/4 PERP, 3.03% of KCCB Net Assets as of 9/30/2020)
- KWG Group Holdings (KWGPRO 5 7/8 11/10/24, 2.00% of KDDB Net Assets as of 9/30/2020)