SCB CIO cautions against China's real estate investment amidst slowdown, recommends avoidance of high-yield bonds for 1-2 years Unlocking High-Return Potential: Capped Floored Floater Notes and Callable Notes

Tuesday 12 September 2023 15:07
SCB CIO sees a global interest rate situation that raises concerns about Chinese bond issuers' ability to repay debt. As a result, it's advisable for investors to avoid Chinese high-yield bonds for the next 1-2 years due to the elevated risk. In 2024-2025, there will be approximately USD 37.808 billion in high-yield bonds maturing. Thai bonds, totaling 4.4 trillion baht, include about 95% investment-grade bonds and 5% high-yield bonds. Investing in investment-grade bonds offers confidence in timely principal and interest payments, thanks to robust balance sheets that bolster resilience against economic challenges. Investors looking for USD-denominated options can consider Capped Floored Floater Notes, offering around 4.6% annual returns, or one-year Callable Notes with potential returns of approximately 5.25%.
SCB CIO cautions against China's real estate investment amidst slowdown, recommends avoidance of high-yield bonds for 1-2 years Unlocking High-Return Potential: Capped Floored Floater Notes and Callable Notes

Mr. Sornchai Suneta, CFA, Chief Investment Officer of SCB Wealth and Executive Vice President of SCB Investment Office and Product Function at Siam Commercial Bank, has revealed a significant presence of Chinese corporate bonds in the high-yield bond market of Asia, excluding Japan. Data from the Bloomberg Asia Ex-Japan USD Credit HY Index indicates that approximately 20% of these bonds belong to Chinese companies, with an additional 20% allocated to the real estate sector, including bonds issued by Country Garden Company, a current topic of discussion. This year marks the maturity of USD 850 million, with substantial outstanding obligations in the upcoming years, particularly during 2024-2026 when maturing bonds amount to a staggering USD 11.152 billion.

China's real estate sector has faced challenges due to its sluggish economic growth, resulting in diminished housing demand. Additionally, global interest rates remain elevated, posing difficulties for Chinese bond issuers, especially those dealing in US dollars. In light of these circumstances, the SCB CIO advises caution and suggests refraining from investing in Chinese high-yield bonds for the next 1-2 years, as significant challenges persist. Notably, in 2024-2025, a substantial sum of high-yield bonds issued by Chinese companies, approximately USD 37.808 billion, will mature, representing nearly half of the bonds due between 2023 and 2043.

Mr. Sornchai further underscores the underperformance of high-yield bonds from Asian companies, excluding Japan, with a decline of approximately -4.94% compared to the end of 2022, while investment-grade bonds have yielded positive returns. Specifically, China's high-yield bonds have experienced a more substantial decline of -14.64%, surpassing the overall market decline. This decline reflects the ongoing concerns within the real estate sector. Consequently, investors are advised to remain cautious and refrain from investing until there is an improvement in China's housing demand and a reduction in interest rates.

Regarding the Thai private sector bond market, it boasts a total value of approximately 4.4 trillion baht. A substantial portion of this market, approximately 95%, is composed of investment-grade (IG) bonds, leaving only 5%, roughly equivalent to 220 billion baht, as high-yield bonds. The IG bonds currently do not raise concerns as bond issuers continue to meet their obligations, repaying principal and interest on time. However, some companies that have issued high-yield bonds face challenges. In light of this, we strongly advise investors interested in Thai bonds to exercise caution when considering high-yield bonds. It is prudent to opt for investment-grade bonds, particularly given the prevailing situation of rising interest rates. Increased interest rates can place a heavier financial burden on weaker issuing companies, making them vulnerable. On the other hand, companies issuing investment-grade bonds are better positioned to weather adverse economic conditions expected to slow down in the future.

Mr. Sornchai emphasizes, "Investors should analyze the yield curve of each country to identify compelling investment opportunities. Presently, the yield curve for US government bonds surpasses that of Thailand, especially in light of the United States experiencing an inverted yield curve. The disparity between the yield curves of the United States and Thailand has grown considerably compared to a decade ago. For instance, investing in low-risk USD short-term bonds or money market funds can yield approximately 5% annually, whereas money market funds in Thailand provide a return of around 1.68% per year. Similarly, investing in USD investment-grade bonds yields more attractive returns compared to Thailand."

We advise investors with experience or those willing to assume exchange rate risk to consider investing in USD-denominated bonds, such as Capped Floored Floater Notes issued by financial institutions. These structured bonds are tied to an interest rate that determines both the minimum and maximum returns, offering an annual yield of approximately 4.6%. Alternatively, they may explore USD Callable Notes, debt instruments that issuers can redeem before maturity with a term of approximately one year, potentially yielding around 5.25% per year.

For investors seeking investment-grade bonds through mutual funds, numerous funds specialize in investment-grade debt instruments, providing an appealing alternative. For those interested in investing in US dollar bonds but are concerned about exchange rate fluctuations, SCB CIO recommends considering Dual Currency Investment (DCI) transactions. DCIs are structured bonds that utilize foreign currency for future settlement, with the target exchange rate pre-determined. Upon maturity, if the exchange rate aligns with the agreed-upon rate, the bonds will convert into US dollars at that rate. However, should the exchange rate fall short of the target due to baht depreciation, investors will receive the principal amount along with returns in baht.

Source: Siam Commercial Bank