China fixed income outlook 2023: The worst is over
China’s fixed income market is set to recover from hitting a bottom in 2023 and offer some diversified opportunities for investors, including the property sector, fund managers said.
AXA Investment Managers noted that Chinese property developers may have reached the bottom. The percentage of China property companies in its universe – the JP Morgan Asia Credit Index (JACI) – was 12% as of the end of 2020, and 8.7% in November 2021. In December 2022, it dropped to 3.4%.
Across Asia, with performance expectations turning positive, the drive for alpha begins to turn from defence back to offense, said James Veneau, head of Asian fixed income at AXA Investment Managers.
“Volatility may persist for much of 2023, but slowing Fed rate hikes and Chinese policy stimulus should limit drawdowns and allow Asian credit strategies to generate positive total returns for the first time in three years,” Veneau said.
However, like in the equities market, investing in the debt market in China also requires a bottom-up approach. While some in the market have turned bullish on China’s US dollar-denominated investment grade debt, most remain cautious despite attractive valuations.
SIGNS OF RECOVERY
In late November, Chinese regulators fired the so-called “three arrows” to rescue the property sector by offering liquidity, including allowing bank credit, bond issuance, and equity financing. Some large developers reached agreements with state-owned banks to secure loans.
This should have given distressed property developers a six-to-12-month window to recalibrate their finances, said Paul Kalogirou, Manulife Investment Management’s Asia head of client portfolio management.
Overall, the China credit market has also shown signs of recovery lately. Some bonds that were once trading below 20 cents on the dollar have climbed back to 70 cents.
However, Kalogirou thinks investors still need to be “very, very cautious" about China’s debt market as household demand for property and property transactions in China is still going through a difficult time.
Besides the property sector, China’s reopening should also benefit issuers such as Macau casinos and industrial companies, which are areas the Manulife team is looking at in 2023, Kalogirou said.
After three years of isolation from the rest of the world, China announced last week that it would resume quarantine-free travel into the country and resume visa issuance for residents starting January 8.
Kalogirou stressed China's recovery in the level of mobility and consumption are key factors for bringing back global investors.
RECESSION IMPACT ON ASIA
As the Federal Reserve remains hawkish coming into the new year, the market expects interest rates to stay higher for longer, which should translate into higher yields for fixed income.
Fidelity International sees recession as its base case, and expects a weakening economy to lead to lower long-term rates, according to Belinda Liao, a portfolio manager at Fidelity International. This would be positive for long-duration bonds.
Meanwhile, China’s reopening and long-term economic transition creates a tailwind for China and the broader Asia economy, Liao said.
“If you put all those together, that actually sets a good backdrop for US dollar-denominated Asia investment grade market,” she said.
The fund house is particularly interested in China’s state-owned enterprises (SOE) and companies in the consumer sector. Outside of China, the firm is also looking at gaming and other leisure-related companies in Asia.
Liao thinks the recession’s impact on Asia investment grade will be “minimal” in terms of downward or default risks, as Asian issuers’ balance sheets are usually in good shape even in a bad year, such as back in 2020.
“I will pay more attention to geopolitical tensions as well as more of the US dollar strength, how that will impact Asia, especially on the sovereign side,” Liao said.
VOLATILITY TO REMAIN
As Chinese policy support kicks in for the property sector, Liao said the team will handpick higher quality developers from the diverse market, as private developers are still an important support to economic growth.
Schroders’ head of multi-asset investments for Asia, Keiko Kondo, agreed with Liao while suggesting China’s equity market will be the biggest beneficiary of the country’s reopening.
Kondo said developed market investment grade is more attractive and stable compared with China’s fixed income market, whose volatility is set to stay due to continuing property-sector turmoil.
Hence, Schroders favours investment grade bonds in the developed markets, and China and Hong Kong equities in 2023. While the Asian credit market, which is still largely about China, is also starting to look interesting, investing would require careful bottom-up issuer selection, Kondo said.