Investors underestimate CNH credit risk, say fund execs

The Sino Forest debacle – which has seen the Chinese forest plantation operator lose more than 80% of its stock value since the start of June following a damning report from short-seller Muddy Waters – has drawn attention to the credit risk of Chinese corporate bond issuers, say asset managers.

At the AsianInvestor and FinanceAsia Asia-Pacific Debt Investor Forum in Hong Kong this week, fund executives agreed on the attractiveness and potential of the Asian high-yield credit market, but also highlighted concerns.

For one thing, some feel investors are underestimating the credit risk of offshore renminbi – or CNH – bonds and that these largely unrated instruments are not paying sufficient returns for the risk involved.

CNH issue yields as low as 3.5% are “absolutely ridiculous”, given the high-yield credit risk they entail, says Henrietta Gourlay, senior research analyst and portfolio manager at Western Asset in Singapore. "Investors aren't being adequately compensated for the credit risk at these low yields."

Others make similar points. “[CNH is] a very fortunate market not to have contained a Sino Forest,” says Jim Veneau, director of Asian fixed income at HSBC Global Asset Management in Hong Kong. It’s a good way of getting exposure to the currency but the credit risk is being overlooked, he adds.

But that is not stopping investors from piling into CNH issues, although some admit exercising caution and selectivity when doing so.

“China is trying to develop the RMB market, but synthetic RMB bonds are not really part of this process and should be seen separately,” says Ben Rudd, head of overseas investment at Ping An Asset Management in Hong Kong, speaking on another panel.

The big market will be CNH bonds, because that’s what the regulators in China are indicating, he says. Hence Ping An concentrates on CNH issues and doesn’t invest in synthetics, adds Rudd.

That said, investors must ask the question of the manager of their CNH portfolio, he says: how much credit analysis is really taking place? 

Also on the subject of investor protection, HSBC’s Veneau says it’s encouraging that credit protection for bondholders is improving in Asia. However, he adds, it will be interesting to see what kind of protections are put in place in less developed markets such as China, Indonesia or the Philippines. “The track record has not been good so far,” he says.

Gregor Carle, fixed-income investment director at Fidelity International in Hong Kong, says that he has seen issuers seek to make tweaks to credit covenants that might materially weaken bondholder protection.

“Investors should just shut the door on such approaches,” he says. “They should have strength to then go back and say ‘this is the deal we agreed on’, and not be swayed by insufficient short-term potential upside for longer-term reduced protection for bondholders.”

The problem with seeking to enforce bondholder rights, says Gourlay, is that the investor base is so fragmented in Asia that it often makes sense to take an extra, say, 2.5% of yield if they can get it, because investors don’t have the power to influence convenants like they might in Europe.

Another concern raised by panelists about Asian high-yield bonds is over the ability to monitor individual issues properly.

Gregor Carle of Fidelity and Laura Acres of Moody's Investors Service

“There was so much issuance in the first quarter that I don’t think anyone had enough time to do enough work on all of them,” says Western’s Gourlay. “I think if people spend more time working on them they might find there are companies they don’t want in their portfolio.”

Fidelity’s Carle agrees: “No investors like being in markets that are going too fast to keep up with,” in terms of having time to do the work on individual credits.

In high-yield markets, he adds, there isn’t such certainty of going back to find liquidity once a bond has come to market and started trading as there would be in higher-quality instruments. Hence the initial trading window is very important, he says, and investors need to have done their research early enough.

But Laura Acres, senior credit officer at rating agency Moody’s Investors Service in Hong Kong, says: “With regard to due diligence, the analysis can be subjective and the timeframes for such analysis are typically short."

As a result, “the important thing is the underlying sponsor's willingness to engage and play ball when things go wrong. But that is difficult to quantify, which is why track record is so important”.