investment viewpoints

    China’s crackdown: Asia’s enduring appeal for convertible bonds

    China’s crackdown: Asia’s enduring appeal for convertible bonds
    LOIM Convertible Bonds team -

    LOIM Convertible Bonds team

     

    Starting with the suspension of Ant Group’sIPO in November 2020, the surge in regulatory risk for China companies has intensified, encompassing the internet, tutoring, food-delivery and property sectors. But amid the volatility, we believe a long-term perspective is justified: in time, the new rules can bring benefits that support the appeal of Asia for convertible bond investors.

    China’s policy crackdown stepped up in July as ride-hailing firm DiDi was pulled from app stores on data-security grounds, all companies in the after-school tutoring (AST) were sector forced to operate on a not-for-profit basis and food-delivery companies required to pay workers above the minimum wage and provide insurance. Mortgage rates also rose in the Shanghai market as regulators moved to cool the property sector.

    The government actions saw the Hang Seng index fall 6.8% from 23-28 July but rebound 3.3% on the 29th after the authorities held calls with Wall Street and China banks. Contagion beyond Hong Kong and China seems unlikely: the Hang Seng is down more than 8.3% month-to-date while the Taiwanese index is marginally negative, and the S&P 500 and Stoxx Europe 600 rose slightly by 0.2% and 0.5% respectively from 23-29 July2.

     

    Portfolio implications

    China and Hong Kong exposure represents about 7% of our global portfolio and includes holdings in food-delivery firm Meituan, e-commerce group Alibaba, internet giant Tencent and farming-technology platform Pinduoduo3. In our Asia portfolio, exposure to China and Hong Kong accounts for 48% of the total equity sensitivity. The impact of the market sell-off has been eased by the following characteristics of our strategy: diversification by country and theme, the absence of any exposure to the AST sector, and the fact that our overweight to the China internet sector is built on what we believe to be resilient, quality names like Tencent and Alibaba. Both firms have A+ credit ratings from S&P and expected year-on-year gains in operating profit of 21% and 27% respectively over the next three years4.

     

    Short-term pain, long-term gain?

    Increased regulatory pressure has hurt sentiment towards large, high-growth names in the technology and consumer-cyclical sectors. We do not believe that the authorities aim to stifle entrepreneurship, but take the view that they are implementing policies that will incur short-term pain for the sake of longer term gain.

    Essentially, the government appears to be seeking to align its regulatory regime with changes in industries and sound global practices. Until last year, some China tech platforms were operating under very light regulations, and the stronger protection of consumer data now required is essential for long-term competitiveness in the global market. Better conditions for gig-economy workers are also supportive of sustained growth and have a clear social dimension. So too do the AST rules, which will prevent the aggressive marketing and pricing exercised by some tutoring firms, which have contributed to inequality in education – especially during the disruption caused by the pandemic.

    It’s important to not lose sight of the bigger macro picture, too. China monetary policy remains supportive, with the central bank likely to keep interest rates persistently low, while the reduced reserve requirement ratio will support SME and personal loans. And, as Asia progresses towards generating an estimated 50% of global GDP by 20405, the region – and China in particular – will become increasingly meaningful in portfolio allocations.

     

    Outlook for Asia convertibles

    We expect the China and Hong Kong markets to stabilise as investors’ focus reverts to China’s macro fundamentals. In our view, convertible bond investors should continue to find opportunities to access growth sectors reflected in the region’s equity markets with less volatility.

    Given the strong primary issuance in the past 18 months, the universe offers exposure to themes that are supported by China’s current Five-Year Plan, including technology independence through semiconductor and renewable-energy production, and healthtech innovation. For example, R&D specialists Wuxi Apptec and Pharmaron are two issuers we favour in the medical sector6.

    Such opportunities are complemented by the characteristic asymmetry of the asset class, which pairs the potential for equity upside with the defensive benefit of a bond floor. In our view, Asia convertible bonds are attractively valued relative to history – particularly since those issued by China and Hong Kong firms have recently sold off aggressively – and this should persist throughout the current volatility, providing the potential for attractive entry points.

     

    sources

    1. Any reference to a specific company or security does not constitute a recommendation to buy, sell, hold or directly invest in the company or securities. It should not be assumed that the recommendations made in the future will be profitable or will equal the performance of the securities discussed in this document.
    2. Source: Bloomberg as at 30 July 2021.
    3. Important information on portfolio composition. The portfolio information provided in this document is for illustrative purposes only and does not purport to be a recommendation of an investment in, or a comprehensive statement of all of the factors or considerations which may be relevant to an investment in, the referenced securities. They illustrate the investment process undertaken by the manager in respect of a certain type of investment, but may not be representative of the Fund's past or future portfolio of investments as a whole and it should be understood that they will not of themselves be sufficient to give a clear and balanced view of the investment process undertaken by the manager or of the composition of the investment portfolio of the Fund. As the case may be, further information regarding the calculation methodology and the contribution of each holding in the representative account to the overall account’s performance can be obtained by the Fund or the Management Company.
    4. Source: LOIM analysis as at July 2021
    5. “Asia’s future is now,” published by the McKinsey Global Institute on 14 July 2019.
    6. Any reference to a specific company or security does not constitute a recommendation to buy, sell, hold or directly invest in the company or securities. It should not be assumed that the recommendations made in the future will be profitable or will equal the performance of the securities discussed in this document.

     

    important information.

    For professional investor use only
    This document has been issued by Lombard Odier Funds (Europe) S.A. a Luxembourg based public limited company (SA), having its registered office at 291, route d’Arlon, 1150 Luxembourg, authorised and regulated by the CSSF as a Management Company within the meaning of EU Directive 2009/65/EC, as amended; and within the meaning of the EU Directive 2011/61/EU on Alternative Investment Fund Managers (AIFMD). The purpose of the Management Company is the creation, promotion, administration, management and the marketing of Luxembourg and foreign UCITS, alternative investment funds ("AIFs") and other regulated funds, collective investment vehicles or other investment vehicles, as well as the offering of portfolio management and investment advisory services.
    Lombard Odier Investment Managers (“LOIM”) is a trade name.
    This document is provided for information purposes only and does not constitute an offer or a recommendation to purchase or sell any security or service. It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful. This material does not contain personalized recommendations or advice and is not intended to substitute any professional advice on investment in financial products. Before entering into any transaction, an investor should consider carefully the suitability of a transaction to his/her particular circumstances and, where necessary, obtain independent professional advice in respect of risks, as well as any legal, regulatory, credit, tax, and accounting consequences. This document is the property of LOIM and is addressed to its recipient exclusively for their personal use. It may not be reproduced (in whole or in part), transmitted, modified, or used for any other purpose without the prior written permission of LOIM. This material contains the opinions of LOIM, as at the date of issue.
    Neither this document  nor any copy thereof may be sent, taken into, or distributed in the United States of America, any of its territories or possessions or areas subject to its jurisdiction, or to or for the benefit of a United States Person. For this purpose, the term "United States Person" shall mean any citizen, national or resident of the United States of America, partnership organized or existing in any state, territory or possession of the United States of America, a corporation organized under the laws of the United States or of any state, territory or possession thereof, or any estate or trust that is subject to United States Federal income tax regardless of the source of its income.
    Source of the figures: Unless otherwise stated, figures are prepared by LOIM.
    Although certain information has been obtained from public sources believed to be reliable, without independent verification, we cannot guarantee its accuracy or the completeness of all information available from public sources.
    Views and opinions expressed are for informational purposes only and do not constitute a recommendation by LOIM to buy, sell or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change. They should not be construed as investment advice.
    No part of this material may be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorised agent of the recipient, without Lombard Odier Funds (Europe) S.A prior consent. In Luxembourg, this material is a marketing material and has been approved by Lombard Odier Funds (Europe) S.A. which is authorized and regulated by the CSSF.
    ©2021 Lombard Odier IM. All rights reserved.