TheChek News Flow

Global asset managers under pressure to cut holdings as Beijing clamps down on developers

Michael Li, a China-focused high-yield bond fund manager based in Hong Kong (who prefers not to speak under his real name), is struggling to attract new investment even though he has outperformed the market by a big margin.

“My portfolio is down 12 per cent, while the benchmark is down 40 per cent,” says Li, comparing his year-to-date performance with an index that tracks hundreds of dollar bonds issued by Chinese companies. “How can I tell my client, ‘Do you want to buy a fund that loses money a little bit less than the others?’ I have no story to tell.”

This downturn follows a slump in China’s offshore property bonds, which make up the bulk of the country’s once-lucrative dollar-denominated high-yield debt. They suffered as Beijing’s crackdown on property speculation in the second half of last year prompted dozens of local developers to default on interest and principal payments.

The divergence between a hawkish US Federal Reserve, which has hiked interest rates five times this year, and a dovish People’s Bank of China that is under pressure to relax monetary policy to rescue the sluggish economy, has dealt a further blow to Li’s performance. Investors have raced to ditch Chinese bonds in exchange for better-yielding assets in the world’s largest economy.

Many international bond investors are reassessing their whole China strategy in the wake of the country’s uncertain outlook, which is being weighed down by Beijing’s zero-Covid policy and intervention in the private sector.

“Chinese bonds are certainly investable,” says Satya Patel, head of fixed income at Matthews Asia in San Francisco. “They’re just much less attractive than they were even at the beginning of 2022.”

Public records show issuance of China’s offshore dollar bonds — those issued by local businesses in Hong Kong — fell by more than a third in the first nine months of 2022 compared with a year earlier. The picture is similarly bleak in the onshore market — for renminbi-based debt issued in Shanghai — as international investors have cut holdings in China’s interbank bond market for a straight seven months since February.

Mark Baker, Hong Kong-based head of fixed income at Abrdn, estimates China’s domestic debt market has recorded an outflow of about $80bn since the beginning of this year, reversing a “significant” proportion of inflows from previous years.

More than two-thirds of the dollar bonds issued by Chinese developers are trading below 70 cents on the dollar as Beijing cut lending to developers and put restrictions on home purchases, causing a spike in defaults. That suggests investors have priced in more than $130bn in losses from holding these debt instruments.

The central government has unveiled a slew of new measures — from cutting mortgage rates to easing purchase restrictions — in a bid to rescue the property industry, which accounts for a third of China’s economic output. But its efforts have fallen far short of investors’ aspirations.

“That did shake confidence in the market and that confidence is not close to returning,” says Baker.

Patel of Matthews Asia, which holds Chinese offshore property bonds, shares this view. “The key thing we’ve learnt over the past 16 months is that the Chinese government is not going to step up and give developers the liquidity [they seek]”, he says. “Investors are also not going to step up and . . . plug the gap.”

According to Morningstar, the five largest Asian high-yield bond funds trimmed their holdings in Chinese developers to 16.4 per cent in June from 27.6 per cent last December.

A weakening Chinese currency, which has lost 11 per cent against the US dollar since the beginning of this year, has added another layer of uncertainty to western buyers of onshore bonds.

“Foreign investors are taking currency risks and they’re at risk of losing all the yields they earn in their Chinese government bonds just because of currency depreciation,” says Patel.

But, in spite of the bleak mood, most international investors still see Chinese bonds as an indispensable part of their portfolio. Baker says buying renminbi-denominated onshore debt could help diversify his portfolio thanks to the low correlation between Chinese bonds and western bonds. “When global markets are selling off, China can still be relatively stable,” he says.

However, the unique nature of the Chinese market — characterised by the heavy state intervention responsible for much of the real estate turmoil — has also made investors wary of risks that traditional models cannot predict.

“The decoupling of Chinese bonds from the rest of the world could make them riskier in the long run,” warns Bo Zhuang, a Singapore-based sovereign analyst at Loomis Sayles.

Researchers focus on pathogens including Covid, herpes and Epstein-Barr virus

For more than 30 years, Professor Ruth Itzhaki has been accumulating evidence that viruses — and particularly the common herpes virus HSV-1 — are involved in Alzheimer’s disease.

But persuading the scientific world to take seriously the idea that viral infection plays a big role in degenerative brain conditions has been a struggle for Itzhaki and like-minded researchers. Now, though, she feels the tide of biomedical opinion is turning in their favour, at last.

“So many more observations have emerged recently,” says Itzhaki, who works at Oxford university’s Institute of Population Ageing. Five hundred studies using different approaches have supported the view that viruses play a role in Alzheimer’s disease, she points out.

Susan Kohlhaas, research director of the charity Alzheimer’s Research UK, acknowledges the relationship between viruses and the disease “is an active field of investigation, with lots of things happening”. But she adds: “The jury is still out on quite what the role of viruses is.”

Itzhaki’s most recent study, carried out with colleagues at Tufts University in the US and published in the Journal of Alzheimer’s Disease, demonstrated how HSV-1 could trigger the early stages of dementia by interacting with the related varicella zoster virus (VZV), which causes chickenpox and shingles.

As Itzhaki originally showed in the early 1990s, HSV-1 lies dormant within the brains of many elderly people. Using Tufts’s three-dimensional neural tissue culture to model the brain, researchers found that VZV could activate HSV-1, leading to an accumulation of tau and amyloid proteins and loss of neuronal function — hallmarks of Alzheimer’s. On its own, VZV had little effect.

“Our results suggest one pathway to Alzheimer’s disease: a VZV infection which creates inflammatory triggers that awaken HSV-1 in the brain,” says Dana Cairns of Tufts. “While we demonstrated a link between VZV and HSV-1 activation, it’s possible that other inflammatory events in the brain [such as head trauma] could also awaken HSV-1 and lead to Alzheimer’s disease.”

Clinical trials at Columbia University and New York State Psychiatric Institute, are gathering more direct evidence for the role of HSV-1 in Alzheimer’s. Participants who are in the early stages of the disease and infected with HSV-1 are receiving either valacyclovir, an antiviral herpes drug, or placebo. Completion is expected in December 2023.

Interest in the links between dementia and viruses has also been increased by the Covid-19 pandemic, as evidence accumulates that Sars-Cov-2, the virus responsible for Covid, can affect the brain in some patients.

An extensive study of Sars-Cov-2’s persistent neurological and psychiatric effects was published in August by other researchers at Oxford university. They analysed the electronic health records of 1.25mn people diagnosed with Covid and a matched control group who had other respiratory infections. Among people aged 65 and over, 4.5 per cent of Covid patients developed dementia over the subsequent two years, compared with 3.3 per cent of the control group.

But, as Kohlhaas points out, the first cases of Covid were recorded less than three years ago — and it can take longer for the initial neural triggers to lead to symptoms of Alzheimer’s disease. “We haven’t had enough time to follow through and understand what the implications of Covid are for people who may one day develop dementia,” she says.

Itzhaki suspects that Sars-Cov-2, like VZV, increases the risk of Alzheimer’s by reactivating latent HSV-1 in the brain. People with the gene ApoE4 appear particularly vulnerable. In an effort to assess this, neurologists from 25 countries have set up a global collaboration: the Alzheimer’s Association Consortium on Chronic Neuropsychiatric Sequelae of Sars-Cov-2 Infection.

“No available evidence supports the notion that cognitive impairment after Sars-Cov-2 infection is a form of dementia, whether it is Alzheimer’s disease or related dementias or some other cause,” says the consortium’s leader, Gabriel de Erausquin of the University of Texas Health Science Centre at San Antonio. “The . . . multinational initiative will provide data to answer this question as clearly as possible in a globally diverse set of participants.”

Researchers are exploring links between viruses and other neurological conditions, too. “Several papers have appeared recently about viruses and Parkinson’s disease,” says Itzhaki. “And Epstein-Barr virus [EBV] has been implicated in multiple sclerosis.”

A team led by Alberto Ascherio from the Harvard TH Chan School of Public Health studied more than 10mn US military personnel from 1993 to 2013, who had blood samples taken every two years as part of routine medical screenings. The results appeared in the journal Science last January. They compared samples from 800 people who developed MS with 1,500 matched controls who were free of MS. People infected with EBV were 32 times more likely to develop MS than uninfected people. There was no association between MS and other human viruses. “This is the first study providing compelling evidence of causality,” Ascherio says.

New York-based Saba Capital profits as bond prices slump

Global stock markets could be heading for a Japan-style bear market lasting decades, says the hedge fund manager credited with spotting the “London Whale” derivatives trader a decade ago.

Boaz Weinstein, whose New York-based Saba Capital was one of the world’s top-performing hedge funds in the market turmoil of 2020, said that the unwinding of central banks’ vast stimulus programmes in an effort to combat high inflation could lead to “doldrum” markets for a prolonged period.

“I’m very pessimistic. There isn’t a rainbow at the end of all this,” Weinstein told the Financial Times. “[Quantitative tightening] is going to be a real headwind for investors.”

“There’s no reason that this difficult [economic] period will only last two to three quarters [and] . . . no reason to think we’ll have a soft landing or a shallow recession,” he added.

Saba’s Master fund, which bets on dislocations in credit and equity markets, had risen 73.2 per cent in 2020 and is up 31 per cent so far this year, according to a person who had seen the numbers.

Meanwhile, tail risk funds betting on equity market volatility are up 13.2 per cent this year, according to the CBOE Eurekahedge Tail Risk Hedge Fund index.

Weinstein, whose firm manages $4.8bn in assets, pointed to the fact that investors have to contend not only with the ending of central banks’ programme of bond buying over the past decade but also its reversal. The policy, known as quantitative tightening, involves selling bonds back into the market.

The US Federal Reserve has so far shown little sign that it will slow the pace of its tightening, which includes winding down the near-$9tn balance sheet it built up over years of loose monetary policy, with core consumer price inflation in the US rising to 6.6 per cent last month.

Developed markets, he said, “could certainly” follow the pattern of the Nikkei 225, which is still around 30 per cent below its all-time high reached in 1989.

“That changed the psychology about whether being a stockholder is such a prized” status, he added.

Weinstein, a former co-head of global credit trading at Deutsche Bank, founded Saba in 2009. He hit the headlines in 2012 when he was credited with having taken the other side of the trade to JPMorgan Chase proprietary trader Bruno Iksil, nicknamed the “London Whale”, whose outsized credit derivatives trades cost the bank $6bn in losses.

Weinstein said he is holding credit default swaps — insurance against default — on cyclical and volatile credits, as he believes that a recession will inevitably lead to corporate defaults and credit spreads widening dramatically.

He also believes they are a better form of insurance than equity market options, which may not rise sharply if equity markets grind lower rather than plummeting.

Weinstein said the apparent lack of panic selling in the current bear market so far was down to the many different issues — including inflation and rising interest rates, energy costs, the war in Ukraine and an economic slowdown in China — that investors are having to grapple with.

“In this sell-off you have so many things that are problematic swirling around, some that are contradictory. There’s a lot of fear, but there’s been a lot of time for people to think about [the issues].

“This year has been like a horror movie but with five monsters — you don’t know what to focus on, so you deleverage.”

Weinstein said he has written credit swaps on companies he believes “never have a problem”, such as Disney, McDonald’s and PepsiCo, and that he argues are priced by investors too close to more financially unstable companies.

The linchpin of the country’s energy security faces maintenance and pipe-corrosion problems plus labor unrest

ARIS—France is falling behind in its plans to return the country’s fleet of nuclear reactors to full power this winter after a rash of outages, raising fears that one of Europe’s key sources of electricity won’t be ramped up to counter Russia’s squeeze on the continent’s energy supplies.

The nuclear fleet was designed to act as the front line of France’s energy security. Since Moscow cut the flow of natural gas to Europe—plunging the continent into its biggest energy crisis since the 1970s oil shock—France’s vaunted nuclear fleet has been about as effective as the Maginot Line, the French fortifications that did little to stop the German invasion during World War II.

Twenty-six of France’s 56 nuclear reactors are offline for maintenance or because of corrosion on piping that cools the reactor cores. Fixing the corrosion is taking longer than expected at several reactors, delaying their restart by as much as six weeks, according to regulatory filings and a French nuclear executive familiar with the matter.

Labor unrest is another obstacle. Strikes at 18 reactors owned by EDF SA, France’s state-controlled power giant, have delayed their restart by several weeks, threatening the government’s plans to have all of them back online by the end of the winter. EDF and union leaders said they reached an agreement Friday on salary increases, ending the strikes.

“It’s important that this work restarts as soon as possible,” said Emmanuelle Wargon, head of France’s energy regulator. “If not, the risk of not having electricity rises.”

EDF, the world’s largest owner of nuclear plants, is one of Western Europe’s most important power companies. Its fleet of reactors normally exports large quantities of low-cost nuclear power to neighboring countries, helping stabilize prices across the region.

The situation changed drastically this year, when France swung from being one of Europe’s largest exporters of electricity to a net importer because of the outages at its reactors. The rash of outages has officials worried that France and the broader region might run short of electricity in the winter, when power demand in Europe peaks.

Soaring energy prices have fueled labor unrest that is compounding France’s energy problems. A strike by French refinery workers led by the CGT, France’s far-left union, has created gasoline and diesel shortages across the country. The workers are demanding a 10% pay increase to cope with inflation. CGT workers have also led the strike at EDF, demanding a minimum pay increase of €200 a month, or roughly $200.

Virginie Neumayer, a CGT leader at EDF, said their strike has targeted the reactors that were either undergoing maintenance or taken offline for refueling. It hasn’t slowed repairs at around 12 of the reactors that were taken offline because of suspicions of corrosion, Ms. Neumayer said.

Still, two reactors that were shut down to check for corrosion have had their startup dates pushed back by as long as six weeks, according to regulatory notices. One of them, at the Flamanville plant on France’s north coast, was delayed from Oct. 9 to Nov. 26; startup at the other reactor, at the Bugey plant near Lyon, was pushed back from Sept. 30 to Nov. 3.

A French nuclear executive said those delays were the result of unanticipated complications in the repairs. The executive said repairs at the Chooz nuclear plant on the Belgian border were also taking longer than anticipated, jeopardizing a Nov. 13 startup date for the first of the plant’s two reactors. The strike could have an impact on the repairs if workers are diverted to work on maintenance rather than fixing corrosion, the executive said.

An EDF spokeswoman declined to comment on delays to the restart of the French reactors.

The corrosion problem is at the origin of the series of EDF outages this year. A technician discovered the problem late last year at Civaux, France’s youngest nuclear-power plant. The phenomenon, known as stress corrosion, was identified on welds for pipes that are under high pressure near the reactor core, according to France’s Nuclear Safety Authority. Engineers inspected the same section of piping in other reactors and found similar problems.

The issue prompted EDF to accelerate maintenance and refueling of other reactors to ensure that they could be available this winter, given that the availability of the reactors where corrosion was suspected was in doubt.

French nuclear experts have said EDF’s calendar for repairing the reactors is ambitious given the difficulty of the work. Repairs on the corroded pipes must be performed within the radioactive containment area of the plants, limiting the time that welders can spend on the job because of rules limiting their radiation exposure.

Officials believe the corrosion is the result of changes that France made to a reactor design by U.S. company Westinghouse Electric Co. that is the basis for a number of French reactors. The design also underpins the U.K.’s Sizewell B reactor, which is owned by EDF’s British subsidiary, EDF Energy.

EDF Energy is planning to inspect pipes close to Sizewell B’s reactor core when it is shut down for planned maintenance in February, said spokeswoman Marjorie Barnes.

Detecting the phenomenon is difficult because it can incubate for decades without producing warning signs.

“It is only possible to identify its presence once cracking has begun,” according to a note from France’s Institute for Radioprotection and Nuclear Safety. “Regular inspections of the pipes can only identify the phenomenon once a fault is present.”

The outages have forced EDF to absorb huge losses because the company was forced to buy replacement power on Europe’s wholesale market, where prices have soared, for sale to retail clients at much lower prices. Last month, the company said the outages would hit pretax earnings this year by around $29 billion. That comes on top of more than $10 billion in losses the company is likely to book because of the French government’s decision to cap retail electricity prices.

The government of President Emmanuel Macron said in July that it would buy the 16% of EDF that the state didn’t already own, at a cost of nearly $10 billion.

Let innovators in, so standards develop and productive services can be delivered.

Apple CEO Tim Cook was asked recently about the dreaded green bubble—the one that appears when you send a message to someone without, gasp, an iPhone running the proprietary iMessage app. But it’s worse than that. His questioner added, “I can’t send my mom certain videos and she can’t send me certain videos and so . . .” Mr. Cook interrupted with a chuckle and said, “Buy your mom an iPhone.” Corporate hubris usually precedes a downfall.

Interoperability can make or break technology, and much is still broken. Many Google apps don’t work well on an iPhone. Why? Apple wants you to use its apps, interoperability be damned. The iPad only recently added support for a mouse, but it’s not good enough for iPads to replace Mac computers and laptops. Why? To protect Apple’s $35 billion Mac business. Users suffer. Technology has a long history of ignoring interoperability. America Online ran its business like a walled garden. More hubris that didn’t end well. It even had two messaging services, AOL Instant Messenger and ICQ (I seek you), that couldn’t send messages to each other until 2003.

In 1990 a judge ruled that competitors infringed Lotus Development’s copyright on its 1-2-3 spreadsheet’s command structure and keystrokes. But it turns out that file formats can’t be copyrighted or patented, allowing Microsoft Excel to read and write Lotus 1-2-3 spreadsheets. This interoperability was a boon to users, though in the end not so good for Lotus, as the company didn’t innovate enough beyond spreadsheets. To protect its Windows operating system, Microsoft was slow to embrace internet protocols like TCP/IP and mobile standards such as Bluetooth and lost its edge in both.

Standards matter. Think of road widths, gasoline mixtures and lights that don’t blind opposing drivers. The 120/220 volt electricity divide was fixed via sensors that allow travelers to use their computer and phone chargers universally, although with different plugs. AA batteries were introduced in 1907, standardized in 1947, AAA in 1911 and 1969. Cellphone standards were another benefit to users and keep evolving—6G isn’t coming until 2030 or so.

To figure this out, Facebook aka Meta announced the purchase of Within, maker of virtual-reality fitness app Supernatural. Almost immediately, the Federal Trade Commission fought the purchase. Yes, there should be some caution about one company monopolizing the Metaverse the way Apple monopolizes the iPhone ecosystem and discriminates within iMessage. But the market is still tiny. The Journal reports Meta’s Horizon Worlds has a meager 200,000 monthly active users so far.

Some form of the Metaverse will happen, but we’re still in the Palm Pilot stage of development—clunky, expensive equipment and low-resolution offerings that don’t do much. That will change. Reinventing education alone will make it worth it. Who cares if Meta buys a fitness app? In Silicon Valley, many companies are bought not for their products but for their people. This is known as acquisition hiring, or “acquihires.” Heck, some venture capitalists build companies just to be bought.

My free-market instincts make me allergic to government intervention. Instead, as in financial markets, government’s role is to set up rules for the sandbox and then let everyone play in it. Let the best sand castle win. Make sure everyone can get in and out of the sandbox on equal terms. We almost have to let Meta or anyone buy companies early in the development of the Metaverse to tinker with applications and business models and prove to others what works, enticing them to join in.

If I were the FTC, I’d let Meta, Microsoft or Google make as many acquisitions as they want for the next decade, but only in exchange for open standards and interfaces so that competing firms can build their own version of this space to connect and be interoperable with what already exists. Governments are involved with standards—the National Institute of Standards and Technology is part of the U.S. Commerce Department. But instead of defining details of these new worlds, the focus should be on sensible interfaces and application programming interfaces so everyone can access the sandbox.

When there are standards for basic technology formats and protocols, battles move higher up the value chain, to more important things, such as delivering real productive services rather than worrying if things made by Google will work with things made by Meta. This would benefit us all rather than letting Tim Cook protect long-in-the-tooth products such as the iPhone. Standardizing the past is what will force innovators to buzz the Hive or swirl the Vortex and invent the future.

But monetary policy alone will not be enough to bring yields down

An unorthodox interest rate rise of 12 per cent by Hungary’s central bank should be a winner for foreign investors in the €930bn local currency government bond market. The move last week was meant to prevent further depreciation of the forint. That is one of three elements needed to lower the yields and raise the prices of government debt.

The other two items to watch are fiscal policy and the release of EU funds. The first looks well anchored. The government has shown determination in keeping spending down. The release of EU funds is less assured. The government seems confident this will happen in December. The EU has yet to say.

The central bank’s move had two immediate effects. The forint soared against the euro. It is up almost 4 per cent since the rise on October 14. Bond yields also rose as prices fell, with the benchmark 5-year yield up 0.6 percentage points to 12.23 per cent over the past week, according to Refintiv data. The government hopes the currency will hold its gains and bond yields fall back. It is in with a chance.

On Friday, the central bank widened its “interest rate corridor”, between the unchanged policy rate at 13 per cent and the overnight collateralised loan rate, up 9.5 points to 25 per cent. The one-day deposit facility offers 18 per cent, which the bank can raise at will. The aim is to suck liquidity out of the foreign exchange and interbank markets. That is bad news for investors who have shorted the forint since the central bank called a halt to its policy rate tightening cycle last month.

The bank also said it would offer foreign currency directly to energy importers, taking a further chunk out of the market. Hungary’s bill for imported energy is about €12bn; that aside, it would run a current account surplus of almost €3bn. It is far more exposed to soaring energy costs and has much less room to diversify supplies, particularly away from Russia, than other countries nearby.

Taken together, the bank hopes its measures will strengthen the forint and help it fight inflation by keeping import prices in check. That, along with fiscal discipline, should be good for bondholders. The rest is up to Brussels.

Warning that rising interest rates could prompt prolonged downturn

UK commercial property market valuations are falling at their fastest pace since the Brexit vote and dealmaking is stuttering to a halt, in early indications that higher interest rates could tip the market into a prolonged downturn.

According to index provider MSCI, UK commercial property values fell 2.6 per cent last month, the largest monthly fall since July 2016.

“It’s a fairly gloomy outlook. There’s clearly a great degree of uncertainty in the market at the moment,” said Tom Leahy, head of real assets research for Europe, the Middle East and Asia at MSCI.

The outlook is similar across much of Europe as investors have retreated following rapid dealmaking at the start of the year. In the first nine months of 2022, a record €229bn of transactions were completed. But in the past three months levels were down 16 per cent on the same period last year, according to property company CBRE.

Rising rates and mounting risks in the economy have quickly transformed the outlook for European property owners.

Borrowing costs — a function of central bank rates and lenders’ perception of risk for the sector — have increased sharply in the past six months, while inflation has driven up construction costs.

The attractiveness of property has also diminished as bond yields have risen. If they remain high, commercial property yields — which move inversely to prices — will have to increase considerably to tempt investors back.

“Why would anyone bother buying commercial property if gilts remain above 5 per cent,” said the head of real estate at a large bank. Property yields have dropped as low as 3 per cent in some sectors.

Leahy expected the unwinding of almost 15 years of ultra-low rates to trigger price falls in commercial real estate across Europe.

He warned that the UK could be particularly exposed to a downturn as a result of recent political turmoil. With a leadership contest underway following the resignation this week of Liz Truss as prime minister, the country is set for its fifth Conservative prime minister since 2016.

“The notion of the UK as a safe haven is coming under severe pressure because of our politics,” said Leahy, adding that political stability had been “in our favour for a long time — London was popular during the financial crisis for that reason — but there is a sense that the ship is slightly adrift at the moment”.

Property brokers and investors said the UK commercial property market peaked at the turn of the year.

According to CBRE, investment volumes have dropped for three consecutive quarters. The number of pending transactions tracked by MSCI is at its lowest level since 2013, indicating that the market is likely to slow further.

Deals that were being struck were at a substantial discount to the levels valuers considered realistic at the start of the year — before the war in Ukraine and surging inflation led to successive rounds of rate rises.

The biggest deal to go through in recent months was Landsec’s sale of Deutsche Bank’s new City of London office, 21 Moorfields.

Late last year, Landsec was privately approached by a potential investor willing to pay about £1bn, according to people with knowledge of the offer.

Landsec instead opted for a public sales process and last month settled for almost 20 per cent less, agreeing a £809mn deal with Australian developer Lendlease.

Analysts and investors said property owners in northern Europe, particularly Germany and the Nordics, were also exposed to a downturn.