Bloomberg/Shanghai

Chinese investors are facing what local brokerages have dubbed an asset famine, as falling yields force them to hunt for riskier bonds in an echo of the buildup to the global financial crisis.
The average yield on AAA rated corporate notes due in one year has slid 146 basis points in 2015 to around five-year lows at 3.23% after central bank rate reductions. That contrasts with the 4.87% targeted returns that Chinese banks, the nation’s biggest bond investors, advertise in their wealth-management products with similar maturities, according to data from consultancy CNBenefit.
Chinese fund managers are struggling to make money as slumping yields and a stock rout force them to plunge the depths of creditworthiness even after at least five defaults this year. Issuance of corporate bonds rated AA or below surged to 120.9bn yuan ($19bn) in September, the most in sixteen months, according to China Investment Securities Co. Before the financial crisis in 2008, investors piled into risky higher- yielding products such as securitised subprime mortgage debt.
“The recent surge in junk bond issuance in China resembles the exuberance of risky debt sales in the US before the financial crisis,” said Ji Weijie, a bond analyst at China Securities Co in Beijing. “In both cases, borrowers experience worsening credit profiles and it is hard for them to repay the debt with cash from daily operations.”
Mounting delinquencies amid the weakest economic growth in a quarter century are raising the stakes for President Xi Jinping, after he allowed the country’s first default last year. In the latest missed payment, state-backed steel trader Sinosteel Co failed to pay interest due Tuesday on 2bn yuan of 5.3% notes maturing in 2017.
“Investors are chasing lower-rated bonds because there are few alternative options available for investments during this so-called asset famine,” said China Securities’ Ji. “We are in an era of low interest rates but the returns that investors promised their clients haven’t fallen much. It’s risky to put too much focus on yields and too little attention to credit risks.”
The rally pushed down down the extra yield on five-year AA- graded corporate securities over AAA notes by 13 basis points this month to 106 basis points, the least this year. Wealth management products, which package assets including bonds into securities sold to individuals, exceeded 20tn yuan as of August after rising to 15tn yuan at the end of 2014, according to central bank and China Banking Association data.
“In China, investors are used to higher returns from wealth management products,” said Tommy Xie, a Singapore-based economist at Oversea-Chinese Banking Corp “Banks are using leverage and buying high-yield bonds to boost returns to meet their clients’ yield target, which is increasing risks of a bubble as we saw in the equity market.”
As many troubled companies have got external help to avoid defaults, investors tend to ignore risks, said Qiu Xinhong, a fund manager in Shenzhen at First State Cinda Fund Management Co.
Sausage maker Nanjing Yurun Foods Co, which had said it wasn’t sure it could repay a note due October 18, later said it would repay. The government in the eastern province of Jiangsu, where Yurun is based, asked local lenders to help the firm, according to a SWS Research report. Two calls to Nanjing Yurun went unanswered Thursday.
“The market still blindly places bets on implicit guarantees,” said Shenzhen-based Qiu at Cinda Fund Management. “It’s like we’re walking in a field with land mines.”
China is seeking a balance between preventing turbulence and giving market forces a bigger role.
“Absolute credit risk is rising,” said Zhou Hao, a senior economist in Singapore at Commerzbank. “But the market is not recognising it.”