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Buyer beware: bond investors need to get thorough

Magnifying glass due diligence from Adobe 17Aug20 575x375
By Morgan Davis
17 Dec 2020

How important is reading the offering circular (OC) on a bond? Not very, according to some investors. However, that approach sets a dangerous precedent.

It can be easy to forget how important it is to approach new investments with fresh scepticism and an eye on the details.

This is especially so when the primary bond market in Asia heats up, with one deal after the other — mainly from Chinese borrowers — hitting investors’ screens rapidly. In such situations, investors sometimes tend simply to buy bonds from an issuer they are comfortable and familiar with. The OC gets little more than a glance.

How prevalent is this practice in Asia? By some estimates, a lot more than one would imagine.

During a recent GlobalCapital Asia roundtable on the Chinese high yield debt market, one hedge fund manager estimated that fewer than 10% of investors were likely to read an OC before making an investment. He pointed to an example of China Fortune Land, which can change its bond terms with 66% approval — which he doubted many investors in the credit were aware of.

The issuers on the roundtable agreed that investors often overlook the details of the transactions. The chief financial officer at one high yield Chinese property company, for instance, said that in the four years his firm has been issuing dollar bonds, no one has asked about the OC. Investors check on market conditions and the fundamentals of the company, but never question the fine print on the bond.

There is, of course, a large element of trust in a company that is a prolific issuer and transparent in its communication to investors, so this practice may cause no headaches. But the way 2020 has gone — with Covid temporarily shutting bond market access for some high yield Asian credits, numerous corporations left hanging in the balance by stuttering growth, and rising liquidity pressure and shock defaults in China’s onshore debt market — more risks are likely to be right around the corner. Investors need to pay closer attention.

Even the best-intentioned borrower may find itself in a distress situation, and be forced to pull out all the stops to keep from defaulting on a bond. Investors may lean on the borrowers and management teams that they know and trust, using them as a guide to which bonds to invest in.

That's a good first step, but it should not be the last.

Take for instance the recent defaults that have happened in onshore China. Many of the embattled names have government ties — something investors had assumed in the past would provide a backstop for financial difficulties. Tsinghua Unigroup Co, which missed a payment on a $450m bond last week, is 51% controlled by government-owned Tsinghua University. State-linked Yongcheng Coal and Electricity and Huachen Automotive Group have similarly defaulted in recent weeks.

These missed payments caused surprise and concern among investors onshore and offshore, but they also raised a key question. Did the investors have a solid understanding of the companies and the bonds they were buying into? Or did they simply take the government ownership for granted and look little into the bond terms?  

A call for investors to read the OC thoroughly and ask the right questions is needed. The recent news from China should serve as a wake-up call for their due diligence practices. Next year may bring a lot more stability if the vaccine rollout proves successful, but there may still be dangers lurking in the debt market.  

By Morgan Davis
17 Dec 2020