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Here's what China's real estate debt crisis could mean for Asia junk bond investors

Jan 7, 2023

Moody's estimates show that China's economy includes more than 25% in real estate and related businesses.


China's property bonds were once key performance drivers in Asia for junk bond funds. However the market share from property securities has dropped due to China’s property debt crisis.

CNBC is advised that Asian high-yield bond investors should expect lower returns.

CNBC has learned that the market capitalizations of these real-estate bonds have fallen from an average 35% to 15% within some Asia high yield funds, as the debt crisis led to lower prices for property bonds.

Traditionally, property bonds form the bulk in the Asia high Yield universe. As their market value dropped, their share in Asian junk bonds market fell as well. Fund managers began to look for other types of bonds in order to make up those losses. However, investors in these high-yield fund might not again be able find the same type of returns.

High-yield bonds (also known as junk bonds) are non-investment-grade debt securities that have higher default risks and require higher interest rates to offset those risks.

Carol Lye (associate portfolio manager at Brandywine Global), stated that China real estate's share has dropped substantially. The market remains very broken, with only high quality developers able refinance.

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The drop is mainly due to a combination of lower bond supply and defaulted bonds falling out of the indexes, according to financial research firm Morningstar.

Patrick Ge, research analyst with Morningstar, said that China real estate's role in the Asian credit universe is decreasing.

China Evergrande was the world's biggest property developer. It defaulted on its loans last December. The consequences of that crisis spread to other companies in China's property industry. Other developers displayed signs of strain: some missed interest payments, and others defaulted altogether on their debt.

Although fund managers are moving to other areas to address the China realty gap, analysts warn that these new alternatives are unlikely to yield better yields than their predecessors.

"Shifting to other sectors and countries [away from the very high yielding China property space] certainly reduces relative yield [to the index] in the portfolio," said Elisabeth Colleran, emerging markets debt portfolio manager at Loomis Sayles.

"However, managers need to think about what yield can actually be achieved with the loss from a default," she told CNBC.

The China property crisis has led to increased interest in Indonesian highyield investments.

Carol Lye

associate portfolio manager, Brandywine Global

Ge stated that funds that were more heavily invested in China's realty bonds have outperformed funds with lower weights on Chinese property bonds. But that is no longer true.

"It's unlikely that this will be the case going forwards, at least for the short-term given the sector's ongoing liquidity struggles and damaged reputation," he said.

China's huge real estate sector has been under severe pressure over the past year, as Beijing tightened its reliance on developers and saw an increase in housing prices.

Filling the gaps

Morningstar reports that Asia's high interest bonds fund managers are shifting money out of China property. Instead, they are diversifying their portfolios into India's renewable energy, and metals sectors.

Ge says that others are also seeing potential upsides in Indonesian real-estate, as they anticipate benefiting from low mortgage interest rates and extended government stimulus, to support the Covid recovery.

"With lower Chinese supply, interest in Indonesian-high-yield Indonesians has grown since China's property crisis," Lye, Brandywine Global, stated. "Indonesia was relatively more stable, as it benefits commodities. There are housing demand and inflation is under control.

Investors may be less likely to invest in Asia high yield portfolios in Southeast Asia because of their "relatively safe" credit quality, and lower default risk.

Morningstar's Ge stated to CNBC that portfolio managers will need to rely more on their bottom-up credit selection abilities to pick the winners/survivors in this sector. Bottom-up investing focuses more on individual stocks than macroeconomic factors.

Lye said that diversifying into other industries is a good thing because it allows investors to diversify their portfolios. However, Lye warned that it can also pose risks.

Road ahead for developers

After a series of downgrades, China's property debt crisis has led to a plunge in investor confidence in its ability to repay its debt.

Moody's reports that real estate firms have had difficulties in attracting overseas finance has also highlighted the challenges faced by these companies.

Annalisa Dichiara a senior vice-president at Moody's stated that "the US dollar bond marketplace remains largely locked to Asian [high rate] companies, raising concern over companies' capability to refinance the large upcoming maturities."

Moody's predicts more Chinese real estate developers to default this year on their debt -- 50% of the 50 names that Moody's covers are currently under review for downgrading or have a negative outlook.

Data released in June showed China's subdued real estate market.

According to China’s National Bureau of Statistics. Real estate investment decreased by 4% over the first five of this year.

According to Goldman Sachs analysis of official data, property prices in 70 Chinese towns remained low in May. This is 0.1% less than one year ago.

Evelyn Cheng of CNBC contributed to the report.

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