Investment implications of the Mainland real-estate debt crisis for Greater Bay Area (GBA)

5 October 2021

Winson Fong, Senior Portfolio Manager, Greater China Equities

Concerns about potential defaults by real-estate developers have triggered risk aversion in the market, prompting a sell-off in property-related stocks. However, “real estate” is a broad term encompassing residential, shopping malls, and retail properties, with considerable regional differences. In this Investment Note, Winson Fong, Senior Portfolio Manager, Greater China Equities, discusses the implications of the current debt crisis for equity investors, as well as various opportunities in the Greater Bay Area (GBA).

1. The Mainland real-estate debt crisis indicates further credit tightening in the sector. Will this event result in systemic risk?

Investors should first understand an important fact: the real estate sector has long been a focus of the Chinese government. From 2016 onwards, it has reiterated at high-level meetings that “residential properties are for housing, not for speculation.” Numerous policies have since been implemented to curb real-estate speculation (excluding moves to combat COVID-19 last year). This has included enforcing the “three red lines” policy¹ in 2020 and 2021 to discourage real-estate speculation through excessive borrowing by developers.

In fact, deleveraging and reducing the financial risks related to real estate have been the government’s primary objectives over the past two years, while investment in the industry has steadily retreated from its peak at the start of 2021.²

Chart 1: Growth rate (%) of investments in real estate development nationwide²

In terms of systemic risk, we believe that the likelihood of credit events at state-owned and private real-estate companies causing a domino effect is rather low. While some might compare the collapse of Lehman Brothers to the latest real-estate debt crisis, the former was an unexpected development; whereas the latter was a gradual process that unfolded over time.

Given today’s era of big data and internet technology, regulators have become much more proficient at anticipating and adapting to change. Meanwhile, the central government has been preparing the property sector for deleveraging in advance. It’s also important to recognise that the real-estate developers’ price-to-book ratios are at wide discounts, implying that their valuations have fully reflected the negative impact from credit crunch caused by deleveraging. The banks’ overall non-performing loan provision coverage is almost 200%³, a solid level far exceeding the required 120%-150% by China Banking Regulatory Commission (CBRC). We believe that there is no need to worry too much about systemic risks like those during the Lehman crisis.

As such, we think that the negative impact of the event on non-performing loans should mainly affect selected banks. Furthermore, the bad news is, to a certain extent, already reflected in the share prices of financials.

Concerns from the market and investors are inevitable, and we remain vigilant of volatility in the real-estate sector over the next three to six months. However, we believe that the real estate sector should come out from this period unscathed and follow a healthy growth trajectory. In our view, market information can be hard to follow at times, so individual investors should seek advice from investment professionals with good research capabilities, especially those who have witnessed many financial crises over the years and understand the characteristics of each crisis.

2. What is the outlook for China’s macroeconomic policy?

Monetary and fiscal policies will generally remain tight. There may be some moderation in regulatory tightening at the year-end Central Economic Work Conference, but since the outbreak of COVID-19, the central government has taken a focused approach by directing resources into strategic industries and providing targeted sector support to those areas closely related to investment and consumption.

It is worth noting that since the pandemic, quantitative easing and the printing of money have instilled international markets with confidence. Yet, such measures may not apply to China. First, printing money could create hot money and lead to speculation. Furthermore, suppose the pandemic persists or worsens. In that case, another round of expansionary (not tapering) measures to bail out markets and see the crisis through may not be possible, hampering the recovery of the external economy. In our view, under this scenario, China’s policy approach may be more favourable, so tighter macroeconomic policies will not be easily changed at this time.

3. How could the debt crisis among Mainland real estate developers impact suppliers in the property (residential-related) supply chain? Which industries do you think will be less affected by this crisis or credit tightening?

Upstream, midstream, and downstream industries linked to the residential sector are more fragmented. Should they require central government support, this could be similar in structure to the measures implemented during the pandemic, such as allowing the delayed payment of loans and a series of initiatives targeted at helping SMEs.

For the real-estate industry, we believe that those financially sound companies may use this opportunity to expand and consolidate, resulting in the strong becoming stronger. Property-management businesses with stable operations have already faced sell-off pressures, but their stock prices rebounded sharply after markets calmed. In addition, the Hang Seng TECH Index has stabilised after undergoing a substantial correction in the third quarter of 2021. This was possibly due to capital flowing back into bellwether tech stocks (which had fallen by 40%-50%) from old-economy stocks (such as finance and real estate) after a period of risk aversion.

4. Will the debt crisis affect nationwide and regional (for example, the GBA) real estate and financial stocks differently?

It is worth noting that real-estate developers in the GBA are primarily diversified businesses with stakes in commercial, hotel, and retail ventures, as well as residential projects. These developers have generally secured other financing channels, possess favourable fundamentals, and are in a better position than developers nationwide.

Aside from real-estate developers and property managers, there are also numerous real estate investment trusts (REITs) in the GBA. Thanks to macro-policy planning⁴ and investments in commercial activities (e.g., office buildings and shopping malls), REITs were more resilient when the developers sold off. REITs can be characterised as generating a potential income plus growth for investors due to their lower volatility profile than stocks, with an earnings yield that ranges from 6%-7%, making this asset class a well-rounded option.

Generally speaking, the Pearl River Delta region consists of solid fundamentals, stronger corporate governance and local demand which translate into better prospects of growth recovery.

5. Mainland property sales have slowed in recent months, but investments in financial assets by Chinese households have continued to grow. In addition to residential property, which investment channels or instruments are most likely to gain traction? And with the launch of the GBA Cross-boundary Wealth Management Connect Scheme, what investments in Hong Kong can attract southbound capital?

First, we believe that the government encourages more diversified, institutionally managed investment products for domestic investors and actively promotes financial market innovation through connectivity.

Following the introduction of the Shanghai-Hong Kong Stock Connect (2014), Shenzhen-Hong Kong Stock Connect (2016), Northbound Scheme (2017), and Southbound Scheme (2021) for stocks and bonds – and after two years of planning, the Cross-boundary Wealth Management Connect scheme in the Guangdong-Hong Kong-Macao Greater Bay Area was launched on 10 September 2021, with service expected to begin as soon as mid-October 2021.

In general, the scheme will allow investors to conduct cross-boundary investments directly in RMB and can offer greater risk diversification among a wide range of investment products.

As previously mentioned, REITs are well-rounded (having both defensive and growth characteristics) investment options. In addition, REIT funds in Hong Kong can act as “super-connectors” between Hong Kong and the Mainland.⁵ REITs may choose to list in HK dollar or renminbi. Besides, the relevant authority has also suggested including REITs in the stock-connect programmes in the future. Once confirmed, investors on either side of the boundary can access each other’s eligible REITs via the stock-connect programmes. For overseas investors in Mainland infrastructure assets, the arrangements are expected to be implemented as a priority. Meanwhile, Mainland investors will have the opportunity to access Hong Kong and global real-estate projects.

We believe the Cross-boundary Wealth Management Connect Scheme will consist mainly of lower-risk products. When REITs can be accessed via stock-connect programmes, funds will likely increase their allocation to REITs, resulting in a potential market revaluation of the sector.

6. How do you manage the policy risks associated with local residential property markets and identify any overlooked opportunities among local real-estate stocks?

In recent years, international investors have taken a great interest in sustainable development. For real-estate developers, helping the government resolve social issues can be seen as an important contribution to the “social” aspect. As the community grows more vocal, we foresee social issues becoming more important in the city’s real-estate development. With an environmental, social and governance (ESG) platform, it can raise the transparency and communication of sustainability issues. Many developers are already providing updates on sustainable development in their investor relations updates and annual reports. They will likely receive more attention from markets on this topic in the future.

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1 In 2020, PBOC and the Ministry of Housing and Urban-Rural Development announced new financing regulations for the real estate industry. Developers wanting to refinance are being assessed against three thresholds: a 70% ceiling on liabilities to assets, excluding advance proceeds from projects sold on contract; a 100% cap on net debt to equity; and a cash to short-term borrowing ratio of at least 1x.

2 National Bureau of Statistics, 15 September 2021.

3 The NPL coverage ratio was 182.23% as of end of 2020, “China Financial Stability Report”, People’s Bank of China, 3 September 2021; the ratio increases to 193.2% as of end of June 2021, according to JP Morgan estimates.

4 The area of Qianhai economic zone will be expanded from 15 km² to 120 km², which should benefit commercial activities in Shenzhen and Shekou.

5 17 September 2021, Financial Services Development Council.

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Certain sub-funds with significant exposure to Renminbi (“RMB”) bonds/equity/assets or emerging markets, may involve debt instrument, credit/counterparty, concentration, liquidity, volatility, currency, tax, economic, foreign exchange/multi-currency conversion, down-grading, regulatory and political risks and these risks could be substantially higher than the risks normally associated with the world's more established markets.
A bond sub-fund may hold a significant portion of assets in deposits if there are not sufficient RMB instruments for it to invest in. This may adversely affect its return and performance.
Certain sub-funds using invest directly in debt instruments/shares via QFII regime, the Bond Connect and/or the Foreign Access Regime are subject to various requirements and restrictions under the laws of Mainland China related to investment in QFII and/or China Interbank Market and custodial risks.
RMB is not freely convertible and is subject to exchange controls and restrictions.
Certain sub-funds may have significant concentrated exposures to particular industry sectors and geography's, which subjects investors to concentration and equity market risk.
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General Risk Disclosure

Funds offered on this platform may invest in equity, fixed income securities, exchange-traded funds, collective investment schemes and/or other instruments, including derivatives, and each of which has its specific investment objective/ policy with its specific features and different risk profile.
Distribution of dividends, the frequency of distribution and the amount/rate of dividends are not guaranteed. Dividend of certain share/unit classes, at the fund or the investment manager’s discretion, may be paid out of capital or gross income while charging / paying all or part of its fees and expenses out of its capital. This amounts to a return or withdrawal of part of an investor’s original investment or from any capital gains attributable to that original investment, and may result in an immediate reduction of the net asset value per share/unit of the respective share/unit classes after the distribution date.
Some funds may invest in bonds or debt securities which may be subject to credit, liquidity, counterparty and market risks.
Some funds may invest in non-investment grade bonds and unrated securities which may be subject to greater credit and liquidity risks, and may be more volatile than higher rated securities. Some funds may invest in investment grade debt securities, which may be subject to ratings downgrades by the rating agencies that may affect the net asset value of the fund.
Some funds may invest in derivative instruments which may involve additional risks. (For example, leverage may cause greater volatility.)
Some funds may make extensive use of derivatives including more complex derivative instruments or strategies to achieve the investment objective, this may give rise to additional exposure in that performance may rise or fall more than it would have done otherwise. In adverse situations, the fund’s use of derivative instruments may become ineffective and the fund may suffer significant losses. The use of derivatives may give rise to leverage, liquidity, counterparty and valuation risks.
Some funds may invest in emerging economies or markets, where special risks, including liquidity, volatility, government policies, taxation, currency, currency repatriation, political and regulatory risks, may be substantially higher than the risks normally associated with more developed economies or markets.
Some funds may invest in securities of small and/or medium sized companies in the relevant markets. This can involve greater risk than is customarily associated with investments in larger and more established companies.
Some funds may invest in a single country/region and/or a particular industry sector which may be concentrated and subject to greater risks than diversified investments in several countries and/or regions and across sectors.
Some funds may invest directly in certain China A shares via the Stock Connect, which may involve risks related to investments via the Stock Connect and Mainland China investment.
Some funds may have significant exposure to Renminbi ("RMB") bonds/equity/assets or emerging markets, which will be subject to debt instrument, credit/counterparty, concentration, liquidity, volatility, currency, tax, economic, foreign exchange/multi-currency conversion, down-grading, regulatory and political risks and these risks could be substantially higher than the risks normally associated with more established markets.
Some funds with significant exposure to RMB bonds/equity/assets may hold a significant portion of assets in deposits if there are not sufficient RMB instruments to invest in. This may adversely affect the funds’ return and performance.
Some funds using Qualified Foreign Institutional Investor (“QFII”) quota to invest directly in debt instruments/shares in Mainland China may be subject to various requirements and restrictions under the laws of Mainland China related to QFII investment and custodial risks.
Some funds are subject to the risks of investing in other funds and the risks relating to asset allocation strategy and/or downside risk management process.
As RMB is not freely convertible, currency conversion is subject to exchange controls and restrictions. There can be no assurance that RMB will not be subject to devaluation. Insufficient amount of RMB for currency conversion or devaluation of RMB could adversely affect the value of investors’ investments in the RMB denominated class(es) of certain funds. The “Dim Sum” bond market is still a relatively small market which is more susceptible to volatility and illiquidity. Due to RMB concentration risk, the value of the funds with substantial RMB exposure may be more volatile than that of a fund having a more diverse portfolio of investments.
Some funds’ performance will be closely tied to the economic, political, regulatory, geopolitical, market, currency or other conditions in the European Economic Area and may be subject to increased liquidity, price, and foreign exchange risk.
Some funds may invest in Russia and some investments in Russian securities may be unlisted securities not dealt on a regulated market. The Russian market presents specific risks in relation to the settlement and safekeeping of securities.
Investment involves risk. Investors may expose to capital loss and should not invest solely based on the information on this website alone and should read the offering documents for details including the associated risk factors, charges and features of the funds and their share/unit classes. Past performance information is not indicative of future performance.

Manulife Global Fund

Manulife Global Fund is an umbrella fund comprising a number of sub-funds investing in equity and/or fixed income securities, each of which has a different investment objective and risk profile and may involve equity market, geographical concentration, sovereign debt, liquidity, volatility, credit downgrade, interest rate, counterparty risks.
The relevant distributing class of the sub-funds does not guarantee distribution of dividends, the frequency of distribution and the amount/rate of dividends. Dividends may be paid out of income, realized capital gains and/or out of capital of certain sub-funds in respect of Inc share class(es). Dividends may be paid out of realized capital gains, capital and/or gross income while charging all or part of their fees and expenses to capital (i.e. payment of fees and expenses out of capital) in respect of MDIST (G) and R MDIST (G) share class(es). Dividends paid out of capital of these sub-funds amounts to a return or withdrawal of part of the amount of an investor’s original investment or from any capital gains attributable to that original investment and may result in an immediate decrease in the net asset value per share in respect of such class(es) of the sub-funds.
Certain sub-funds invest in emerging economies or markets, where special risks, including liquidity, volatility, government policies, taxation, currency, currency repatriation, political and regulatory risks, may be substantially higher than the risks normally associated with more developed economies or markets.
Certain sub-funds invest in securities of small and medium sized companies in the relevant markets. This can involve greater risk than is customarily associated with investments in larger and more established companies.
Certain sub-funds concentrate their investments in a single country and/or a particular industry sector are subject to greater risks than diversified investments in several countries and/or regions and across sectors.
Certain sub-funds may invest directly in certain China A shares via Stock Connect, which may involve in risk related to Investments via Stock Connect and Mainland China investment.
Investment involves risk. The sub-funds may expose their investors to capital loss. Investors should not invest solely based on this material and should read the offering document for details including the risk factors, charges and features of the sub-funds and their share classes.
Each sub-fund intends to use financial derivative instruments (“FDIs”) for investment, efficient portfolio management and/or hedging purposes. The use of FDIs exposes the Fund to additional risks, including counterparty/credit risk, liquidity risk, valuation risk, volatility risk and over-the-counter transaction risk.
Given RMB is currently not a freely convertible currency, payment of redemptions and/or dividend payment in RMB may be delayed due to the exchange controls and restrictions applicable to RMB. As offshore RMB (CNH) will be used for the valuation of RMB denominated Class(es), CNH rate may be at a premium or discount to the exchange rate for onshore RMB (CNY) and there may be significant bid and offer spreads and thus the value of the RMB denominated Class(es) will be subject to fluctuation. Any devaluation of RMB could adversely affect the value of investors’ investments in the RMB denominated Class(es) of certain sub-funds.

Manulife Advanced Fund SPC

Manulife Advanced Fund SPC is an umbrella fund comprising a number of sub-funds investing primarily in equity and bond securities, each of which has a different investment objective and risk level.
The sub-funds do not guarantee distribution of dividends, the frequency of distribution, and the amount/rate of dividends. A sub-fund may at its discretion pay dividend out of capital or gross income while charging / paying all or part of its fees and expenses out of its capital. This amounts to a return or withdrawal of part of an investor’s original investment or from any capital gains attributable to that original investment, and may result in an immediate reduction of the net asset value per share of the respective share classes after the distribution date.
Certain sub-funds with significant exposure to Renminbi (“RMB”) bonds/equity/assets or emerging markets, may involve debt instrument, credit/counterparty, concentration, liquidity, volatility, currency, tax, economic, foreign exchange/multi-currency conversion, down-grading, regulatory and political risks and these risks could be substantially higher than the risks normally associated with the world's more established markets.
A bond sub-fund may hold a significant portion of assets in deposits if there are not sufficient RMB instruments for it to invest in. This may adversely affect its return and performance.
Certain sub-funds using invest directly in debt instruments/shares via QFII regime, the Bond Connect and/or the Foreign Access Regime are subject to various requirements and restrictions under the laws of Mainland China related to investment in QFII and/or China Interbank Market and custodial risks.
RMB is not freely convertible and is subject to exchange controls and restrictions.
Certain sub-funds may have significant concentrated exposures to particular industry sectors and geography's, which subjects investors to concentration and equity market risk.
Certain sub-funds may invest in equities of small- and mid-capitalization companies, which can expose investors to liquidity and volatility risks, and is subject to greater risk than is customarily associated with investments in larger capitalization companies.
Investment involves risk. The sub-funds may expose to a high risk of capital loss. Investors should not invest solely based on this material and should read the offering document for details including the risk factors, charges and features of the sub-funds.

Manulife Hong Kong Series

Manulife Hong Kong Series (“the Series”) is an open-ended unit trust comprising a number of funds primarily investing in equities, debt securities, exchange-traded funds and/or collective investment schemes, each of which has a different investment objective and risk level.
The funds do not guarantee distribution of dividends, the frequency of distribution, and the amount/rate of dividends. Dividends may be paid out of capital and/or out of gross income of certain funds in respect of Inc classes, while charging/paying all or part of certain funds’ fees and expenses to/out of capital of certain funds. This represents a return or a withdrawal of part of an investor's original investment amount or capital gain attributable to that amount. Distributions will result in an immediate decrease in the net asset value of the relevant units. Class AA (RMB) Inc Hedged Unit of certain funds is subject to higher distribution risks than other non-hedged unit classes.
Certain funds may involve equity market, emerging markets, Dim Sum bond market, concentration, volatility, liquidity, credit, credit ratings, below investment grade and unrated securities, credit rating downgrading, interest rates, valuation, sovereign debt, unlisted debt securities, political and regulatory, currency, foreign exchange, derivative and structured product, hedging, and distribution risks.
Certain funds are subject to the risks of investing in other funds and the risks relating to asset allocation strategy and/or downside risk management process.
Certain fund is subject to the risks of investing in other funds and the risks relating to investment in exchange traded funds, Strategic and Tactical Asset Rebalancing Strategy (“STARS”), small- and mid-capped companies, convertible bonds and the risks associated with securitised debt instruments and investments in loss-absorption features. Certain fund is a feeder fund that invests all or substantially all of its assets in another collective investment scheme (the “master fund”) and is therefore subject to the risks of investing in the master fund.
As RMB is not freely convertible, currency conversion is subject to exchange controls, and restrictions. There can be no assurance that RMB will not be subject to devaluation. Insufficient amount of RMB for currency conversion or devaluation of RMB could adversely affect the value of investors’ investments in the RMB denominated class(es) of certain funds. The “Dim Sum” bond market is still a relatively small market which is more susceptible to volatility and illiquidity. Due to RMB concentration risk, the value of the funds may be more volatile than that of a fund having a more diverse portfolio of investments.
Certain fund will not have direct investments other than cash, cash equivalents and financial derivative instruments (such as futures, options and forwards).
Investment involves risk. The funds may expose its investors to capital loss. Investors should not make investment decisions based on this material alone but should read the offering document for details, including the risk factors, charges and features of the Fund and its unit classes.