The global investment climate is currently in the midst of a major transformation, and averting the pitfalls contained within requires a keen eye for a multitude of emerging challenges and opportunities. Nowhere else is this more the case than in Asia, where markets are subject to a sustained spat of volatility and the potential for returns is huge. Mrassociates spoke to Chew Heng Yong and Roger Carlsson, Portfolio Manager and CEO respectively of fund management company Chiliogon Asia, about the Asian credit market and the risks associated with it.
What is the investment climate like at the moment?
Last year was littered with geopolitical risk events, as we saw conflicts in Syria, Gaza and Iraq escalating, and tensions between the West and Russia worsened over Ukraine. Whereas over in Asia, we have ongoing China territorial disputes against Japan and Vietnam, Thailand reverting to military rule, and protests in Hong Kong brewing over China’s proposed electoral reforms.
However, geopolitical risk is generally being underestimated and volatility suppressed, largely due to the open monetary operations at the US Federal Reserve, ECB and the Bank of Japan. That said, in an ultra low interest rate environment, we have seen investors chasing lower quality risk assets and looking further down the capital structures in search of higher yield. To date, the average yield for high-yield index US dollar bonds, compiled by Bank of America Merrill Lynch, has fallen to five percent, down from 20.8 percent in early 2009.
Geopolitical risk is generally being underestimated and volatility suppressed, largely due to the open monetary operations at the US Federal Reserve, ECB and the Bank of Japan
With that in mind how has the market grown over the recent years?
The Asian credit market has seen corporate credit spreads tightening massively, due to the reasons mentioned above. Companies are taking the opportunity to lower their financing cost by issuing more to refinance existing debt. At the same time, the quality of some new issuances is getting poorer as corporates with tinted history of restructuring are back tapping the debt capital market – and with success. This goes to show that investors are either more forgiving or have a much bigger risk appetite. An example is Indonesian real estate company Pakuwon Jati (single B-rated), which managed to issue a five-year Reg S USD bond at 7.125 percent when it had a history of debt restructuring back in 2005.
As we transition into the new year, we are also seeing riskier bank issuances, as most countries have implemented new banking rules governing minimum bank capital requirements and qualifying capital criteria, hence, we saw a huge supply of Basel-III compliant debt securities. These new higher yielding bank issuances essentially have an unfriendly creditor structure in place, to such an extent that investors hold a higher risk of principle write-down and greater loss absorbency upon the point of non viability trigger.
Another trend we’re seeing in the Asian credit market is companies with weak standalone financials seeking support from Chinese banks when they tap the debt capital market. By getting a standby letter of credit from Chinese banks, these companies have managed to reduce their financing cost when they’ve issued. However, we remain cautious on such issuances, as this structure has been untested.
How has the financial climate affected your business?
As the yield compression continues, we are also looking at various alternatives and instruments that offer better risk-reward ratios. But on the public corporate bond space, we find value in selected Additional Tier 1(AT1) and Contingency Capital Security (CoCo) issues, so as to participate in this space but focus only on high quality names that have ample buffer to trigger levels and excellent asset quality.
As the Asian credit market is extremely exposed to the Chinese property market, we are keeping a very close watch on the contracted sales figures of Chinese property companies on a monthly basis. We are cautious on this sector and thus have set up shorts in under performing property companies as a hedge in the portfolio.
Where are now you positioned within the market?
We continue to maintain a balanced portfolio. Technical may stay strong and stretched valuations persist, but we believe Basel III will create significant pressure on the ability for banks to absorb volatility shocks with less capital allocated to market-making activities. We feel that, in the coming months, it is very important to be cautious and balanced in our approach to risk, as there is no way this will play out without high volatility.
Combined with thin volumes, we are seeing wider bid offer spreads when everyone rushes for the door, which could lead to large swings on the back of very tight pricing. As such, we are taking more but smaller long positions and holding some shorts as a hedge in the event of a sell off.
How successful has Chiliogon been in terms of the fixed income fund? How did you achieve that success?
The Chiliogon RSL Income Fund aims to generate above average returns with low volatility by finding value across capital structure using in-depth analysis, both fundamental and quantitative, and focusing on liquid securities. Since its inception in June 2010, the fund has posted an annualised return of 11 percent with an annualised volatility of 8.7 percent, beating the JACI Total Return benchmark, with an annualised return of seven percent, as of August 2014.
The fund management team does not take unnecessary foreign exchange and rate risks as it proactively hedges out these exposures, and the fund positions itself as a credit fund as we trade on the less volatile corporate credit spreads. The fund has been successful in calling short in some of the distressed coal producers in recent years, and the fund manager has a disciplined approach to all tenets of its functions.
Pre-investment, the fund management team has a strict investment process before investing funds. We use a top down approach, with the management team reviewing the market conditions, and specific investments are made only after running a relative valuation against appropriate peers.
The firm conducts research by speaking to sell side analysts and management teams, and direct communication with CFOs and/or investor relation managers are encouraged to receive first hand comfort and in-depth knowledge about credit. Post investment, the fund abides by a 30 percent corporate bond issuer limit to mitigate concentration risk, and the investment team will diligently monitor fund exposure and hedge risk out.
Where are your strongest areas of expertise?
To generate additional alpha, Chiliogon has maintained excellent relationships with most major underwriting banks in the region, which has given us access to research, capital markets transactions, and companies’ management. We have been successful in acquiring allocations in most heavily subscribed debt issuances, with decent new issue discounts, by meeting up with issuers during pre-deal road shows and providing pricing feedback to banks’ syndicate desks.
We have had a wide range of investors from high net-worth individuals to family offices and funds of funds. As we are based in Asia and close to the action, we are able to deliver on ad hoc requests from investors keen on research in the region. For example, we had an investor based in London who has a particular interest in an Indonesian company, and will hold occasional conference call discussions with the investment team to pick our thoughts on the company and the regional macro environment.
Who is Chiliogon regulated by?
Chiliogon is regulated by Monetary Authority of Singapore (MAS), which ensures that a comprehensive compliance framework is in place before granting a fund management licence to operate in Singapore.
The company conducted background checks on all front/mid-office employees at the end of last year, and on new joiners to ensure that all representatives meet the MAS fit and proper criteria. Besides that, Chiliogon engages the service of ComplianceAsia to ensure that stringent compliance procedures are met and new regulations adhered to.
Can you explain the structure of your company?
As a firm, we bring in-depth investment management experience, specifically buy side experience, to our investors. Given that our seed investors were from a single family, we are an investment management company with a family office ethos. Bearing in mind the importance of capital preservation for the next generation, we are also constantly looking for better yield with reasonable risk return ratios, and are therefore passionate about the alternative investment industry as well.
What other areas does the company cover?
In the alternative investment space, we believe in collaboration and teamwork, technical expertise and resources for detailed due diligence work. Our involvement in these deals ranges from fundamental research with data room access to direct contractual negotiation, before arriving at concrete solutions and actionable recommendations.