US dollar-denominated offshore Chinese bonds, otherwise known ‘Kung Fu’ bonds by some, are beginning to capture investor attention.
Indosuez Wealth Management, for one, is considering the bond sector on the back of climbing issuances and negative performance in the benchmark index, the iBoxx Asia ex-Japan credit index.
The total return of iBoxx Asia ex-Japan credit index, which includes Kung Fu bonds, is negative at -1.3% year-to-date, the first negative performance since 2007, according to Indosuez research.
‘The correction in this index arguably provides interesting entry points for selective sub-segments, in particular for firms with solid credit fundamentals, as there is now a wider spread differentiation between sectors and companies,’ said Maggie Cheng, senior credit analyst.
Cheng expects high yield spreads to come under pressure in the second half of the year on higher expected issuance, especially by Chinese property developers.
The total issuance of Kung Fu bonds in March saw a monthly increase of 48% to $18.9 billion, driven by large issuances by Baidu, China National Chemical Corporation, and the Bank of China Ltd.
Baidu and Tencent were able to issue at tighter spreads than the initial pricing due to over-subscription by investors. In fact, Tencent Holding has issued 5-year, 10-year and 20-year tranches at coupons 25 to 35 basis points lower than initial pricing.
Fitch Ratings expects offshore bond issuance by Chinese corporates to rise in 2018 after hitting a record high of $117.8 billion in 2017 as onshore regulatory conditions tighten, the agency said in a note in January.
‘We expect Chinese investment grade corporates, banking and asset management sub-segments to benefit from a supportive funding environment, better corporate governance regarding leverage, and solid capitalisation in the case of the largest Chinese banks,’ Cheng told Citywire Asia.
In 1999, China established four state-backed asset management companies to buy the non-performing loans of the Big Four banks - Industrial and Commercial Bank of China, Bank of China, China Construction Bank and Agricultural Bank of China.
Cheng said the asset management companies are strategic to the Chinese government in terms of strengthening the banking system in the ongoing process of liberalising the financial markets.The banks could potentially sell their bad debts to foreign investors through these asset management firms.
China has been making a push to liberalise its corporate and government bond markets, opening it up to foreign investors. In July last year, the government launched a ‘Bond Connect’ to allow investors from Mainland China and overseas to trade in each other's bond markets.
More recently, Bloomberg announced a set of tools for tracking Kung Fu bonds and said that it will add China renminbi-denominated government and policy bank bonds to the Bloomberg Barclays Global Aggregate Index from April 2019.
‘While we do not expect this news to immediately trigger large inflows – given expectations of such a move – this is still a clear medium-term positive,’ Nomura research analysts Albert Leung and Prashant Pande said in a report.
As of February, offshore investors held RMB 1.022 trillion ($162.5 billion) of Chinese government and policy bank bonds.