Adviser note: Evergrande and how it effects your clients’ portfolios

By Matt Wacher, CIO, APAC and Brad Bugg, Head of Multi-Asset Strategies, APAC

Over the last several weeks, one of China’s largest real estate developers, Evergrande, has dominated headlines due to ongoing financial troubles related to its debt servicing. While many companies globally are still facing Covid-19 related challenges, Evergrande has caught the market’s attention because of its sheer amount of outstanding debt (currently estimated to be in excess of US $350bn) and its potential to impact global markets.

Already the company has missed several of its interest payments, and with others due in the coming weeks, the concern is that the situation could begin to deteriorate quickly. In the fourth quarter of 2021, the company has repayments on around $1.8 billion of high-yield debt instruments, with approximately another $4 billion due next year. If the situation is not managed properly, there could be significant implications for investors globally given Evergrande’s strategic importance to the Chinese economy. This is highlighted by construction activity having been a huge driver of Chinese economic growth over the last decade and Evergrande having played an integral role in this. Looking forward, this will remain important and be key to China achieving its goals of becoming the largest economic power by 2030, and doubling its 2020 GDP by 2035.

Though impossible to predict, it looks like the potential impact is being taken very seriously with Chinese authorities and the central bank standing by ready to act. At the same time media reports also point to the Chinese authorities pressing the local authorities to support those impacted by a default by Evergrande, moves that have been, so far, embraced by global investors. Overall, action taken by China has been designed more to ring-fence Evergrande, as opposed to a comprehensive bailout of the developer. An important recent development is that Evergrande shares were suspended from trading on Monday pending a “major transaction” where Hopson Development Holdings Ltd, another Chinese real estate developer, announced plans to acquire 51% of Evergrande’s property-services unit.

That said, any misstep resulting in a significant impact to global markets can’t be ruled out and Morningstar is monitoring the situation carefully. The impact could take the form of weaker global equity markets because of softer Chinese demand and/or a sell-off in global credit markets that so much of the market rely on for funding. However, now, major impacts look to be largely contained to Evergrande’s own securities and other Chinese property developers only.

In terms of the positioning of your clients’ portfolios, there is minimal direct exposure to Evergrande (less than 0.1%). This very small exposure is a result of a holding by one of our Emerging Market Debt managers, Ashmore. Elsewhere, the portfolio’s exposure to areas that could be impacted by broader contagion are also limited. Holdings in Australian shares, particularly those with meaningful exposure to the iron ore price, have been reduced in recent months as has corporate bond exposure prior to this issue arising. Exposure to China shares at a total portfolio level is also low at below 5%.

Overall, performance has been encouraging over the last few weeks, during which time markets have experienced somewhat higher than usual levels of volatility. Whilst many global markets have sold off in the last month (the ASX 200 is down ~4.2% since the start of September) your members have achieved superior outcomes. Notably, strong performance of holdings in the Energy and Financial sectors, as well as those with exposure to Japan, has benefitted from the prospect of new political leadership. Positive outcomes notwithstanding, Morningstar will remain vigilant, and continue to assess developments and remain focused on capturing the opportunities that will bring long-term value to your clients’ portfolios.

This document is issued by Morningstar Investment Management Australia Limited (ABN 54 071 808 501, AFS Licence No. 228986) (‘Morningstar’). Morningstar is the Responsible Entity and issuer of interests in the Morningstar investment funds referred to in this report. © Copyright of this document is owned by Morningstar and any related bodies corporate that are involved in the document’s creation. As such the document, or any part of it, should not be copied, reproduced, scanned or embodied in any other document or distributed to another party without the prior written consent of Morningstar. The information provided is for general use only. In compiling this document, Morningstar has relied on information and data supplied by third parties including information providers (such as Standard and Poor’s, MSCI, Barclays, FTSE). Whilst all reasonable care has been taken to ensure the accuracy of information provided, neither Morningstar nor its third parties accept responsibility for any inaccuracy or for investment decisions or any other actions taken by any person on the basis or context of the information included. Morningstar does not guarantee the performance of any investment or the return of capital. Morningstar warns that (a) Morningstar has not considered any individual person’s objectives, financial situation or particular needs, and (b) individuals should seek advice and consider whether the advice is appropriate in light of their goals, objectives and current situation. Refer to our Financial Services Guide (FSG) for more information at morningstarinvestments.com.au/fsg. Before making any decision about whether to invest in a financial product, individuals should obtain and consider the disclosure document. For a copy of the relevant disclosure document, please contact our Adviser Solutions Team on 1800 951 999.