What does Evergrande’s default mean for Chinese investment landscape?
Active management and the ability to assess the environmental, social, governance (ESG) risks are particularly important when investing in politically charged economies, according to Zenith Investments Partners.
The firm’s investment consultant, Calvin Richardson, said it was demonstrated by a ‘controlled demolition’ of China’s second largest developer, Evergrande, which managers had intentionally avoided for years.
“We definitely have not subscribed to the notion that China has become un-investable but we just think you need to be extremely selective in positioning and employ high quality active management to navigate pockets of volatility but you also want to be able to take advantage of mispriced opportunities where the market sentiment,” Richardson said.
“The downfall of Evergrande has really emphasised the importance of active management as Evergrande represented disproportionately large weighting in high yield indices so what you have is the most indebted issuers are the largest constituents in these passive allocations.”
Richardson noted Evergrande’s valuation metrics had been quite poor for some time and, additionally, the company progressively contravened the all the ‘three red lines rules’ introduced last year by the government to improve the financial health of the real estate sector, which in result impacted its further access to financing for their projects.
“We first saw that domino falling first in September and that was when the market really started to take notice that Evergrande is experiencing this acute liquidity stresses. And that was when it became clear that they would likely default on their debt repayments,” he added.
However, at the same time, there were a number of other developers in China which were in the similarly precarious scenario and they were also struggling to meet their debt repayments.
According to Zenith, which portfolios held no exposure to Evergrande’s debt or equity securities, the headline risk was that the credit markets would seize up.
Although there were some mild contagion effects, with lenders, insurers, and suppliers most exposed to Evergrande understandably suffering the most, and the domestic situation in China appearing highly volatile with property prices most exposed to asset deflation, the likelihood of the Chinese Communist Party (CCP) allowing this to transpire appeared low.
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