Financial news

Vulture funds circle China’s debt-laden corporate sector

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Via Financial Times

Wang Yizhi sensed an opening last July when local investors raced to dump the debt of Future Land Development, a Shanghai-based developer, after the arrest of its founder on sexual abuse charges.

Shortly after the scandal broke, Mr Wang, general manager of Raman Capital, bought four-year bonds for 88 cents on the dollar. Within weeks, he had sold them for 95 cents, after the developer put dozens of projects on sale to improve its cash flows.

“FLD is a strong company with a very low probability of default,” said Mr Wang, 35, at his office in Shanghai’s financial district. Shrugging off the founder’s arrest, he added: “We make money by having a better idea than our counterparties of how much risky bonds are worth.”

Raman is among a growing band of hedge funds trying to exploit opportunities in China’s corporate bond market — which the central bank puts at Rmb24.6tn ($3.6tn) — as a slowing economy and a deleveraging campaign by the nation’s leaders send defaults through the roof.

The going has not always been easy: a regulatory crackdown two years ago forced banks to pull cash from Raman, which was named after an Indian physicist known for his work on the scattering of light. But one of the biggest challenges has been getting hold of reliable information in a largely opaque market, which makes operating as a “vulture” fund in China more tricky than in the US or Europe.

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There are times when bond prices fall off a cliff after the publication of a social media post — censored in 15 minutes — that mentions a closed-door government-led meeting where the issuer’s financial problems are discussed. Moreover, some of China’s bond issuers have a reputation for cooking the books and there is a lack of law enforcement to stamp out fraud.

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“The market is certainly not getting more transparent,” said Mr Wang. “Investors and issuers don’t trust each other.”

Mr Wang, a native of the northwestern province of Gansu, moved to Shanghai after graduating from college in 2009 and joined a local brokerage as a research assistant.

Three years later, he launched Raman in a 300 sq ft room with three partners and about Rmb5m ($728,000) in assets. Life was “very miserable” back then, he recalled.

Like many start-ups, Raman struggled for many months to obtain capital. The turning point came after Chinese banks began looking for places to park investment products offered to rich customers. Such products promised high returns, but were kept off banks’ balance sheets to bypass credit controls and other regulatory restrictions.

In 2014 Mr Wang made a breakthrough with Industrial and Commercial Bank of China, the nation’s largest lender by assets, which handed him Rmb450m to manage. Other banks soon followed suit, driving Raman’s assets to a peak of Rmb8bn in 2016.

By then Mr Wang had a lifestyle he could only have dreamt of, growing up in Gansu’s capital, Lanzhou. His family of three moved from a Rmb8,000 per month, two-bedroom apartment to a five-bedroom house in an expatriate neighbourhood for Rmb50,000 a month. He bought cases of Château Beychevelle wine at more than Rmb2,000 per bottle, and drank them like beer.

“I was full of myself when there was easy money to be made,” he said.

But in 2018 Beijing began a crackdown on shadow banking, introducing new rules on asset management that required banks to move wealth-management products back on to their books. That prompted banks to trim bond-backed funds with high risk weightings that could hurt their capital ratios.

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The exodus slashed Raman’s assets, which determine its fee income, by two-thirds within two years.

Worse still, his track record took a hit after several portfolio companies defaulted. “I have paid a price for being overly aggressive,” said the fund manager. He dug in to his own pocket to provide Rmb100m of compensation for his investors, partially offsetting their losses.

Just over a year ago the Wangs downsized to a three-bedroom flat out of the expat enclave. Instead of taking first-class flights and booking five-star hotels, Mr Wang downgraded to economy and Rmb80-per-night hostels.

The setbacks prompted Raman to shift its focus to seeking underpriced high-yield bonds, rather than distressed or special situations, a move that probably saved it from going under. Raman reported a return of 21 per cent last year, slightly higher than his six-year average of 19.4 per cent and putting the investor close to the top of its peer ranking.

However, Mr Wang does not expect such performance to continue, as a rush of capital into the high-yield bond market makes bargains harder to come by.

“I clean my glasses three times a day to make sure I get all the numbers right,” said Mr Wang. “But I am just not sure which issuer is truly safe.”

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