China Zhongji Investment's High-Yield Bond Semiannual Review: Good Opportunities Stem from Market Inefficiency

China Zhongji Investment's high-yield debt investment business, since its launch, has achieved surprisingly high returns in just six months, becoming one of China Zhongji Investment's star businesses.

At the beginning of the business development, Wen Yuanhua, President and Partner of China Zhongji Investment, said that the Chinese economy is in a transition period, and the debt market is full of unprecedented investment opportunities. From the perspective of asset allocation, the rise of the high-yield debt market, or the distressed debt market, is inevitable. From the perspective of China Zhongji Investment's business development, high-yield debt is in line with our risk preference and our own advantages. We are confident and capable of making this business a domestic leader.

What is the secret behind the rapid rise of China Zhongji Investment's high-yield debt business in just six months? What is the core investment logic and experience? Today, Shen Xiao, the investment director of high-yield debt at China Zhongji Investment, will share his insights. Enjoy:

       Q: Why is high-yield debt investment in China attracting increasing attention now?

       A: High-yield debt investment is indeed much hotter than in previous years. I think there are three main reasons:

First, the market is expanding rapidly. With a 10% yield limit, the high-yield debt market this year is likely to be several hundred billion, or even close to a trillion. The market capacity is huge. Second, the performance of high-yield debt portfolios is relatively good. With global bond yields generally falling, it is natural that high-yield debt is attracting more attention. Moreover, the current stage of market development holds many opportunities to earn excess returns. Third, overall liquidity has improved. Before, our market was small, and there were few participants, resulting in poor market liquidity, and the entry barrier was higher. Improved liquidity has lowered this barrier, and naturally, more people are paying attention. These three reasons have mutually influenced and driven the rapid development of the high-yield debt market.

       Q: Where are the main opportunities hidden in the high-yield debt market?

       A: The current opportunities in the high-yield debt market mainly come from the market's weak efficiency Specifically, it is the insufficient market efficiency caused by the insufficient adaptability of the internal control mechanisms and risk culture of institutional investors to the current market situation. We can aim at three directions to find opportunities:

       1. Differences in "Institutional Behavior"

For institutions whose holdings need to be disclosed, such as public mutual funds, once a bond defaults, everyone can see it. Even if the scale of default losses is not large, in order to avoid public pressure, institutions sometimes still sell without regard to cost.

       2. Differences in "Assessment Mechanisms"

For some institutions, the penalty mechanism for losses is much lower than that for risk events. For example, Selling a bond with a net price of 100 yuan for 20 yuan is considered a "loss", while a 20-yuan bond defaulting is considered a risk event. Some institutions' mechanisms favor the former.

       3. Conflicts between Risk Control Mechanisms and Assessment Mechanisms

For some institutions, there is a lack of coordination between risk control and the investment manager's assessment mechanism. Once a default risk is discovered, the investment manager is forced to liquidate.

We believe that in the "sell-off" targets of large institutions, after screening through credit analysis, it will be relatively easy to find good opportunities. However, as institutional mechanisms adjust, these opportunities will also decrease accordingly.

       Q: Is now a good time to enter the high-yield debt market?

       A We can see that compared to 2018, since 2019, the market efficiency of high-yield debt has significantly improved. We originally judged that after May, good buying opportunities would greatly decrease. Fortunately, affected by the "Baoshang Bank" incident, the bond market has formed liquidity stratification and credit stratification, which has also brought excellent buying points for high-yield debt. As long as the irrational "sell-off" behavior we just mentioned still exists, then opportunities will continue to exist. Looking at the current high-yield debt market, due to differences in institutional behavior and unresolved liquidity issues, the average yield to maturity of high-yield bonds is significantly higher than the expected loss rate, providing a significant opportunity to obtain excess returns.

       Q: How to judge the investment value of a trading object?

       A: Like other investments, judging the investment value of a trading object is paramount. We mainly proceed from two angles: macroeconomic research and individual bond credit ratings. For some bonds, especially those with a net price above 75, macroeconomic factors may have a greater impact on their subsequent performance than financial and industry factors. We try to mine a "credit cycle" between the economic cycle and the policy cycle to help judge the overall trend of the credit bond market. Individual bond credit ratings are more complex. We have built a scoring card model, which is divided into several modules: comprehensive attribute evaluation, prudent asset-liability ratio calculation, internal liquidity stress test, external liquidity support, and direct debt repayment sources. The weights between the modules are determined using machine learning methods to learn and confirm from historical data. In short, it is necessary to conduct a more in-depth study of the trading object.

       Q: Predict the future of high-yield debt investment?

       A: In the short term, high-yield debt will continue its current basic state, but we can already see a trend: more and more funds are entering the market, and risk appetite is becoming more diversified. At some point in the future, there may be a "high-yield asset shortage", with prices being bid up to a level that is insufficient to cover the risk. In this process, we need to continuously adjust our investment expectations and investment logic and explore better investment opportunities.