Market Commentary: Supply chain disruptions | Are your portfolios exposed to Evergrande?

01 October 2021

Watch Freddy Lim, StashAway Co-founder and Chief Investment Officer and Stephanie Leung, Group Deputy CIO, discuss the latest global events and their potential impact on the markets and on our investment portfolios.

In this episode:

  1. Pandemic-led supply chain disruptions [1:29]
  2. Are there broader implications on the market from the Evergrande debt crisis? [5:03]


Philipp | 00:01

Hello and welcome everyone to another market commentary from StashAway. I'm very happy to be back after I've missed the last session with my co-host Freddy, our Chief Investment Officer and our Deputy Chief Investment Officer, Stephanie - how are you two?

Freddy | 00:16 

Well, good to have you back, Philipp.

Stephanie | 00:19 

Yeah, exactly. I think our audience missed you.

Philipp | 00:24 

I'm good and I'm excited to be back. And, you know, obviously it's been over the last two weeks since the last call. Obviously, there's a few things that are hitting our screens and news cycles that we want to get into today. So we got a ton of questions also around one topic, which is called Evergrande - we're going to get there in a little bit, but that's not the whole story, right, Freddy? How about you give us a little bit of an update on the markets in general because we're seeing some softening in those over the last two weeks, right?

Freddy | 00:59 

Yeah, it's actually - Evergrande's impact on the market is still quite limited at the moment, but we've seen a combination of many other events going on. And one of the other events going on is, you know, two Fed governors are stepping down because of trading scandals. So, you know, while policy making you are trading in your personal accounts.

Philipp | 01:23 

It's quite interesting that that's still happening these days, right? When everyone knows everyone is visible, right?

Freddy | 01:29 

Yeah, exactly. It's amazing that this kind of governance issue at a government level is actually more prevalent than in securities firms, right? So that's big news. But also you got a lot of stuff like there's a lot of China energy outages and which is related to China's commitment to carbon emissions and states are getting quotas to try to get there. And yet they were overwhelmed with a lot of demands for what they produced. So [02:00] that's this little supply chain problem that's compounding a little more. So supply chain threat, the latest one is China energy, and you have people worrying about inflation still, which is the reason why StashAway re-optimised portfolio in July, which primarily centers around this inflationary pressure from supply chain threats. So those things are coming into play. And in terms of the latest, you also have news that you've got institutional demand for Evergrande's bonds and you have state media saying national players may start looking at the assets that Evergrande has and want to take them off. So that's actually also a silver lining among all these noises, there's just so much going on. So I would say - generally things are slowing because of a combination of many things, not exactly particularly to any one event at the moment.

Philipp | 03:01

Yeah, you can't pinpoint it to just one. If I do go back to - just for the inflation piece, because you said, obviously we already re-optimised a while ago for this kind of scenario. And now that it's - we've done that for a while now and you kind of see it out over the summer, right? It seems to be getting worse. But even I think the Federal Reserve came out a few weeks ago where they said, Hey, they are thinking it's going to be a temporary thing until the supply chain issues are sorted, which will still take a while, right? Do you think it's a temporary thing or is it also driven by an easy monetary policy? Any other insights that you might have Freddy?

Freddy | 03:42

Well, I wouldn't blame the central banks for rescuing the markets, but I would say that it's a function of the COVID-19 pandemic. The widespread impact on the supply chain is a very real thing. You have shoemakers having issues in some way in Vietnam, [04:00] or you basically have issues widespread where some countries are on lockdowns still - they're not advanced in the vaccination cycle and they have these frequent outages themselves. And even China at a port level, sometimes for one case on a ship, they could close down the whole port. So you will have all these disruptions happening quite frequently in the eye of this pandemic that can only be resolved when the industry adjusts to it, which takes a few years or when we manage to reopen because of the vaccination drive or herd immunity, either one of them, right? So there's a natural cycle of order for things to happen, and we felt that as a firm, it will linger for a few years between 1 to 3 years. So we felt that's sort of enough for us to react to it. Generally, our time frame can be even longer, 3 years or more. But in this case, with a 1 to 3 year time frame, we felt that needs to be addressed right now, and we did it in July.

Philipp | 05:03

Absolutely, I think. Thank you for explaining that again, Freddy, why we've done this and I think, like you said, hopefully the Western countries are starting to help on that vaccination drive and start shipping vaccines that are not being used in the western world over to the places where they actually need it. With that being said, let's go into the Evergrande fiasco or saga that we've been covering. Stephanie, any thoughts on Evergrande and broader market implications? We obviously get a lot of questions around that. Do you want to give us a little bit of an update from your point of view there?

Stephanie | 05:43

Yeah, sure. I mean, the whole Evergrande saga, I think, has really accelerated in the past few weeks. But in fact, it's been brewing for quite some time already. If you look at some of the Evergrande credit, look at the bonds, they've actually [06:00] been going down from 82 cents to a dollar to trading at 30 cents to a dollar recently. So I mean, this is due to a few things that are happening in China. Number one, there's been a tightening of monetary policy since the beginning of the year. And then secondly, China is taking a few steps to really curb down on the property sector, namely limiting lending for property developers or even just trying to cap the home prices. So it's very fundamental. I mean, in China, the property sector is actually very, very big. It takes up 30% of GDP, according to some estimates, and this is way, way higher than, for example, in the US or other countries. And given China's concern on credit just accelerating, property, of course, takes up quite a bit of that. And so I mean, it is sort of China's deleveraging effort, and Evergrande has a huge amount of debt as we all come to understand now. But I would say a few things about this. Number one is that the incident seems to be quite isolated. Now of course, S&P also, for example, downgraded a few other property developers who are also in a similar situation as Evergrande. But they are generally quite small. So names like Fantasia, they're a lot smaller. And if we look at the top 10 developers in China by sales, Evergrande was the biggest one. But for the 9 other biggest developers, their bonds are still trading at around 90% to 100%. So it's not a systemic risk from that point of view. I mean, from an Evergrande kind of standalone basis, there are a few risks that China has to manage. Number one is, of course, the unfinished flats that they need to deliver to buyers [08:00] of Evergrande.

Philipp | 08:01

That's the retail side that is, you know, in distress. The actual retail buyers, right?

Stephanie | 08:07

Yeah, and so I mean, you see headlines saying China is instructing the banks to make sure, I mean, these flats are delivered because ultimately, if these flats aren't delivered, there's going to be a lot of disgruntled buyers. And then secondly, for the onshore bonds, we've seen some development last week. Basically, they are resolving the coupon payments. There's very few details disclosed. But those debts are being worked out, restructured, namely, right? If you look at Evergrande's offshore bonds, that may be a different story. These bonds are now trading at 25 to 30 cents on the dollar, which from a western kind of traditional bond investor point of view, these are called distressed debt i.e. the bond market is already expecting them to default. And indeed, there's just one headline this morning that says one of the distressed asset managers in the US have started buying up these offshore bonds. So, I mean, things are moving, and I think the key thing to keep in mind is that Evergrande is a big developer. However, it won't cause systemic risk in China.

Freddy | 09:18

Because they have real assets for even state companies to sort of acquire on the cheap. So like Stephanie mentioned if you assume recovery value is around 25% to 30% of market cap and already your bonds are trading at 25 to 30 cents on the dollar. That means the market has already well embraced and is well prepared for a 100% chance of a default. But the recovery value is basically what's left over that can be sold and scrapped, and that's why people buy the distressed bonds, right? So they're professionals in the industry that focus on that and they're coming in. So I think that, clarify it if I'm wrong. I [10:00] think that's what Stephanie is saying.

Philipp | 10:02 

Yeah, and I think it's also, you know, people have been drawing parallels to '08, '09 and Lehman Brothers, which is a completely different story, right? They were so entangled in the US economy, right? And also every investment bank had their fingers in the game and they were all having.

Freddy | 10:20

Yeah, you're actually right. Even though Evergrande's value was around $300 billion in liabilities and Lehman was $600 billion, 2008 wasn't caused by Lehman alone. The whole subprime market plus leverage, plus the entire banking system, we're talking about a couple of trillions of dollars, right? So I think that's not a fair comparison. But I think the main thing is that we've seen a lot of questions about how much Evergrande holdings that the Asia High Yield corporate bond ETF has and whether they affect KWEB. And I would like to address them here. KWEB is China Tech and it has no exposure explicitly to Evergrande - if there's any sort of correlated risks, it will be the same as with any other person, S&P 500 or anyone. That sentiment? Yes, sure, there's always that correlation risk. But in terms of holdings, none. In terms of Asia High-Yield corporate bond, which is a smaller portion of our Income portfolio, that particular ETF has only a total of 1.14% of market value in Evergrande bonds on the cheap. So the other 98.86% of holdings were not related. So it seems like so far all our systemic risk indicators didn't flare up. Stephanie has mentioned isolated risks and looking at how other developers within China's trading - it looks very isolated. National players are scooping up assets at recovery value. Foreign investors, [12:00] distress investors are interested. So to me, all those points come together to say that it looks like the 1.14% point of exposure in just one ETF out of the many in the portfolio. It seems very, very much like a non-event for StashAway.

Philipp | 12:16

Yeah, absolutely non-event. And I think this is when you get rewarded for staying invested. I think those are always the times - if you listened to us over the last 2 or 3 years now, as long as Freddy and I have done it, we always have these geopolitically isolated things happening right? And they always move on. And you know, in the end, if we would have just stayed put, the markets do move up over time, right? So thank you both for your input on all of those. A lot of questions on that. I do want to remind our listeners there's some very, very interesting webinars coming up in all of our different regions. So first up is actually in Singapore on Tuesday, the 5th of October at 7pm, we have an Ask Me Anything. It's called Introducing Thematic Portfolios - as you might have noticed in your StashAway app or on our website, we launched what's called thematic portfolios, and we will have an Ask Me Anything about it. So join us on Tuesday, the 5th of October  7pm Singapore time, and ask us as many questions you want. We'll give an overview of what they are and how they might fit into your portfolio as well. That's on the 5th in Singapore. On the 12th of October, also in Singapore, we have what's called an International Diversification FX Hedging webinar. So join us for that again at 7pm on the 12th October. For Malaysia, we have an Ask Me Anything also - Introducing Thematic Portfolios. That's on the 6th of October at 6 pm local time. So join us for that. Also in Malaysia upcoming, the week after, on the 13th of October, we have what's called How to Plan For Your Retirement. So [00:14:00] if you want to learn more about retirement planning, what can you do now in order to maybe retire early? Join us for that. And last but not least for our MENA region, we also have our Introduction to Thematic Portfolios - Ask Me Anything. It's actually on Monday, the 4th of October at 6pm local time, so please feel free to join those talks. We would like to see as many of you as possible. As always, we have the signup links in the show notes below. You can also find them on our website, on our Eventbrite page, social media accounts, wherever else you interact with us. We're looking very much forward to seeing you at those. And just a little sneak peek as well. Freddy, myself, and Stephanie will also be recording a podcast in the coming week about thematic portfolios - we'll really go in-depth on that as well. So if you want to take a look out for that, it should come out in a few weeks time on our podcast called In Your Best Interest. With that being said again, Freddy, Stephanie, thank you so much for joining me today. Thank you all for listening, and we'll be with you again shortly. Until then have a wonderful rest of your week. Bye-bye.

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