China vulture funds feast as corporate defaults rise
Debt-market sell-off feeds fast-growing junk bond market worth more than Rmb1.2tn
A new breed of Chinese vulture funds has emerged as rising corporate defaults boost bond yields, creating a fast-growing junk bond market worth more than Rmb1.2tn ($171bn).
The boom has been fuelled by a sell-off in debt markets as issuers ranging from private factories to government investment vehicles run into financial trouble with China’s economy slowing.
However, the high-yield bond bonanza relies heavily on government rescue of troubled borrowers, an expectation that appears increasingly tenuous.
Most vulture funds buy in after issuers show clear signs of distress but before any payments are missed. A small number of investors are bolder, buying bonds that are already in default and thus at a very low price — for instance 10 cents on the dollar — in the hope of an imminent government bailout.
“The value of junk bonds doesn’t depend on credit analysis,” said Larry Hu, an economist at Macquarie Group in Hong Kong. “It depends on the likelihood of a government bailout.”
More than 100 high-yield bond-focused investment groups have emerged since corporate defaults skyrocketed last year, according to East Money Information, a financial information provider. There were fewer than 40 in the previous five years combined.
The rise of vulture investors has been accompanied by a sharp increase in junk bonds as China grapples with its slowest economic growth in 30 years.
A total of 1,434 outstanding corporate bonds yield more than 9 per cent — junk status by local standards, according to East Money Information. That is up from 951 a year ago.
“[The] slowing economy is a boon for junk bonds,” said Shen Xiao, a high-yield bond portfolio manager at Beijing-based Zhongji Investment.
Bond yields have shot up with a record 176 corporate issuers having reneged on debt repayments this year, an increase from 125 in 2018, according to Wind, a financial information provider.
The resulting fire sale of distressed debts by institutional investors, mostly banks and mutual funds, has fed a buying spree by vulture funds snapping up what they consider highly undervalued bonds.
“Bond pricing is getting increasingly irrational as many institutional sellers are offering unusually large discounts to avoid dealing with defaults,” said Jin Yao, a Shanghai-based junk bond portfolio manager.
But more than hopes of a recovery in bond prices, Chinese high-yield investors are banking on the assumption that Beijing will bail out troubled issuers to protect jobs and the economy.
“There are few long-term investors in junk bonds,” said Ivan Chung, an analyst at Moody’s in Hong Kong.
Yet state-led bailouts increasingly are in jeopardy as the central and local governments struggle with shrinking revenue.
Many vulture funds have already suffered heavy losses when an expected rescue package did not materialise.
Wang Yizhong, a Shanghai-based bond portfolio manager, said he lost more than Rmb30m on one-year commercial paper issued by Xiwang Group, a distressed industrial group in eastern Shandong province.
Mr Wang bought the commercial paper after a government-led investment fund pumped Rmb3bn into the troubled corn oil producer. But the money did not resolve Xiwang’s debt problem and local governments were too stretched to provide further help.
“The Chinese government is not as powerful as you think,” said Mr Wang. “They can’t save everyone.”