Hedge funds that won big in China's bond meltdown now see risks

[BEIJING] As default risks surrounding troubled issuers like China Evergrande Group rocked the nation's bond markets last year and left global investors nursing losses, a handful of little-known hedge funds swooped in.

Shenzhen Qianhai Guoen Capital Management, Fuhui Juli Wealth Management and Shenzhen Qianhai Jiuying Asset Management - which between them manage more than 20 billion yuan (S$4.2 billion) - pocketed gains of 319 per cent, 104 per cent and 96 per cent respectively under their high-yield strategies, after scooping up distressed debts issued by property firms and local government financing vehicles.

The returns are all the more surprising as turbulence in China's real estate sector caught out global asset managers including arms of Prudential and UBS Group. And as firms like T Rowe Price Group, Allianz Global Investors and Goldman Sachs Asset Management seek to tap opportunities from the stressed sector, top performing fixed-income hedge funds in the nation are now turning more cautious because they see risks rising further.

While last year's gains were outliers and often boosted by concentrated bets, the price swings helped China's private bond funds - the local equivalent of hedge funds - garner an 8.9 per cent average return overall, the best in at least 5 years, according to Shenzhen PaiPaiWang Investment & Management, a local research provider. That is more than double the 4.2 per cent return in the Eurekahedge Fixed Income Hedge Fund Index.

For Fuhui Juli, which manages less than US$80 million, opportunities arose way back in March last year when China Fortune Land Development became the first developer to suffer a payment failure since Beijing tightened controls of the debt-ridden sector.

Traders at the firm saw that China Fortune's investors were counting on major shareholder Ping An Insurance (Group) coming to the aid of the struggling builder, said Wei Chong, head of bond research at Hangzhou-based Fuhui Juli. "We locked in the potential sellers, waiting for them to offload when their pressures peaked."

Ping An did not help, allowing Fuhui Juli to buy some notes at prices below 15 US cents, netting returns as high as more than 300 per cent in annualised terms when the bonds were sold later as market sentiment improved, according to chairman Yao Zhifeng. That helped push the full-year return of its Xinghui No 6 fund - which targets near-default debts - to 104 per cent, topping private bond funds managing more than 5 million yuan at PaiPaiWang.

The liquidity crisis progressively enveloped more builders, creating the backdrop for Jiuying Asset's best-performing trade in November. The US$2.4 billion asset manager picked up asset-backed securities issued by a medium-sized developer at less than 50 US cents, head of bond investments Shi Zai said, declining to name the issuer. The bet paid off when the debt was repaid on maturity about 2 months later.

While often short-lived, such trading opportunities were hardly rare last year. Shenzhen-based Guo En ploughed into some of KWG Group Holdings' bonds due Dec 17 in mid-November, at prices as low as 91 US cents, pocketing gains when the developer repaid in full a month later, according to Yan Shaodi, head of fixed-income investment. And although real estate bonds brought some of the best returns, both Guo En and Jiuying Asset said bonds from financing vehicles set up by local governments to fund infrastructure projects and other public investments also contributed significant profits.

The top-performing products manage their own money or are tailored for selected clients, allowing for higher risk-taking and concentrated bets. Still, for many investors, China's high-yield debt implosion has sent returns plunging.

Eastspring Investments' Asian High Yield Bond Fund declined 17 per cent last year, according to data compiled by Bloomberg. The fund's performance was mainly impacted by its exposure to Chinese developers' US dollar debts last year, said William Xin, head of fixed income for the China operations of the asset manager, which is part of Prudential.

UBS Group's multi-billion dollar Asian High Yield fund also got caught up in China's high-yield bond meltdown, plunging to its biggest annual loss since inception. Ashmore Group - among the largest holders of US dollar-denominated bonds issued by Evergrande and its subsidiaries - said clients pulled US$2.2 billion in the 3 months to December, amid weaker growth in China and across emerging markets.

Even as the authorities step up liquidity support to stem an economic slowdown, last year's top-ranked managers in China are turning more cautious with little to suggest an imminent rebound. Jiuying Asset is lowering its risk appetite towards debts linked to local government financial vehicles and diversifying its portfolio, fearing that defaults may finally happen as pressures on the financing vehicles mount. While Fuhui Juli is still cautiously adding bets on private developers' bonds, it is capping single investments to 10 per cent of its portfolio, down from 30 per cent last year, amid signs that even well-managed developers are facing serious liquidity difficulties, Wei said.

"The property market is full of big opportunities for us, but both the price declines and the evolution of sector fundamentals have exceeded our expectations," he said. "It's hard for us to tell who can survive." BLOOMBERG