Acre Fixed Income Note Aug 2020 - Acre Capital

Dear friends and investors,

Apologies for not sending this in a while, I have been focusing on rebranding the company as well as making sure that the new fixed income clients that came on board over the last few months are well taken care off. We have also recently moved to a new office at Cecil Street, so do drop me a text if you’re in the area to catch up. The new website should also be ready at the end of September.

Clients would receive a monthly report according to their own portfolios and objectives and while this consolidated report takes a bit more effort, it is something that I would like to restart as a way to communicate our views. I do hope that this is useful for you.

Performance

 

The aggregated Acre fixed income portfolios across all clients are up 0.4% in the month of August 2020. YTD performance stands at +9.2% vs the IBoxx Asia High Yield Index at +3.1%.

August 2020: Further Yield Compression, now at 10-year lows

August saw further credit spread compression (Figure 1) in the High Yield space driven by India and Indonesia as further risk-on sentiment and a global chase for yield continues. The Fed’s inflation targeting policy announced in the month also suggests lower yields for longer. Yields overall have compressed to a 10-year low (Figure 2) in record time since the depths of the Covid crisis back in March. This means that opportunities are no longer as obvious moving forward and more caution should be taken. In any case, Acre’s fixed income accounts have done well YTD and we have been taking profit on longer duration names which have rallied significantly.

Figure 1: August returns driven by Asia High Yield on credit spread compression

Figure 2: Yield to Worst for Asia Composite at 10-year lows

Not Straightforward Anymore – Even with China Property Names

For the last 3 years, China property names have been the “no-brainer” go-to for high yield fixed income funds and investors to get a >8% yield. This is because of structural tailwinds on i) urbanization, ii) housing as a key pillar of China’s economic growth and stability, iii) development as a relatively cash flow friendly business, iv) quantifiable hard assets in event of default and v) monthly data points for ease of monitoring.
However, buying Chinese property bonds are no longer as straightforward due to increasing leverage of China property developers, onshore defaults and various off-balance sheet risks (eg. Evergrande). The latest “Three Red Lines” policy aiming to control developers’ leverage would lead to more risky companies to offer larger discounts and therefore lower margins, while stronger companies would benefit in the longer term. The chart below shows the relative strength of each developer and we have been early buyers of Logan, Country Garden and Shimao bonds which should continue to do well.

Figure 2: Yield to Worst for Asia Composite at 10-year lows

How to Find Yield Moving Forward

With yields at 10-year lows and opportunities not as straightforward today, we are positioned to be more cautious moving forward. As such, we have been taking selective positions in the 5 to 7-year duration range for a yield of 4-6% in investment grade equivalent names with the intent to hold to maturity. This enables the portfolio to continue delivering the required yield that most clients expect while controlling for risk. These opportunities are not obvious and have required an extensive screening and research process to uncover.

Happy to discuss more over a call, coffee or in the office if you’re interested to know more.

Regards,
Vincent

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