How to Find a Pot of Gold in China’s Junk Bond Market

Olivier and Mann - How to Find a Pot of Gold in China’s Junk Bond Market
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Olivier and Mann

One investor has found blue skies overhead in China’s bond market as the country struggles to reduce liquidity.

Beijing’s effort to curb the amount of its currency in circulation has put pressure on the country’s junk debt issuers that have been struggling from the effects of increasing borrowing costs and decreasing demand.

One investor who made it big with the country’s junk debt bonds says that it is creating a much-needed situation that will support the progress of the country’s promising debt capital market.

Elevating the cost of borrowing is preferred more than the selling of assets and will mean that struggling companies will struggle to borrow further, which is an advantage for asset allocation.

A big part of 2016 saw Chinese capitalists with deep pockets readily grabbing debt offerings, which led to borrowing costs falling. However, this all changed last December with the record sell-off in the corporate bond market which was triggered by a clampdown on leverage and concerns over trading practices that were suspected of being fraudulent.

Yields suddenly climbed as the People’s Bank of China (PBOC) heightened its efforts to improve the bank’s one-year lending rate which is being used to measure liquidity before the Chinese New Year holidays.

Chinese officials have been working hard to control leverage in the country’s economy following a 9-year credit spree that has seen the country’s debt-to-GDP ratio to swell to around 247%.

Credit spreads will be smaller with the anticipated fall in yields of high-quality products by the end of 2017 as spreads on junk bonds will stay attractive up to the end of the year.

Staying away from unsafe borrowers who will be experiencing pressures and focus more on quality and long-term debts is the advice given by experienced traders in the market.

Around $30 billion of AA rated or higher bonds will come to maturity this year and with the majority of Chinese companies able to buy back their bonds, it will be at a premium as some of the least capable issuers may be forced to restructure their debt.

Almost 30 companies defaulted on their bond repayments in 2016, an increase of more than four times the previous year.

The pressure in the market, in the end, is important since it enables the optimum application of investment and expense.