Dec. 6, 2021

Evergrande: A Direct Hit On US Funds.

By now we're all familiar with Evergrande, the giant Chinese Real Estate Firm. For US Analysts, over the past few years, Evergrande looked like the perfect off-shore investment.

Not only did Evergrande provide geographic diversification for US Centered Investment Funds. Which, in itself was enough to draw the attention of many fund managers.

After all, each manager is always looking for a way to “beat the competition's performance.” And what better way than to invest in the fastest-growing sector of the World's fastest-growing economy: Chinese Real Estate.

But the appeal for US investment managers didn't stop there. Evergrande had a unique investment model. They sold their Apartments, their principal Real Estate product, as a retirement vehicle for young Chinese wanting to save for their retirement.

For the emerging Chinese young professionals, it seemed like a perfect investment. A kind of Individual Retirement Account that you could end up living in.

To the US Analysts looking to invest, it was a real win-win. A way to participate in this growing demographic trend of Chinese young professionals.

And last, cut certainly not least. Evergrande was a real estate company. That is: their assets were collateralized with the most secure collateral of all: real property.

It was a “can't miss” from the American point of view. A safe, secure way to participate in China's phenomenal economic growth. The Siren Song of American Global Investment.

So, as I understand it, the American funds bought Evergrande offshore Bonds by the boatload full. They simply couldn't get enough. We, know for instance that Blackrock the Largest American Fund company purchased a reported $400 million dollars of Evergrande Dollar Denominated Bonds.

And I'm quite sure that's only the tip of the Ice Berg. No doubt many other American Funds are heavily invested in Evergrande Bonds.

Now, I've reported over the past several months, the deterioration of Evergrande's financial condition. How interest payments have been late in paying. With the offshore, dollar-denominated interest payments lagging behind those of the native Chinese bonds.

Well, this weekend it all began to come to a head, as Reuters reports that Evergrande has filed with the Hong Kong Stock Exchange reporting, quote:

"in light of the current liquidity status...there is no guarantee that the group will have sufficient funds to continue to perform its financial obligations" and pay the $260 billion demanded by creditors.

The statement so alarmed Chinese officials that they immediately summoned Hui Ka Yan,

Evergrande's Chairman to an emergency meeting in Guangdong Province to explain all this.

And, as is the fashion of the secretive Chinese government, no report of the meeting has been made public. So, the rumors are running wild. With everything speculated about: from no action by the Chinese authorities to suspension of all offshore interest payments, to complete takeover of Evergrande by the Authorities.

For us, and for the US Funds, we too can only speculate about the ultimate outcome for Evergrande.

But for investors, you should be aware that there is a settled path upon which their Evergrande bonds will be valued. And like many things in your financial life, it will all be handled by the Accountants.

Fund accountants have a very straightforward, and clear approach to any potential bond default. It's called a “Hair Cut.”

The way it works is this: assuming that the probability of the bonds paying their interest and paying back their principal amount at maturity is 50:50, then the Fund accountants will “hair cut” the bonds by 50%.

Blackrock's bonds would be carried on their books, in this example, at $200 million dollars, not the $400 million they originally purchased them at.

Now, of course, if the fund accountants believe that there is no chance that the bonds will meet their interest and maturity payments will be made. Then the bonds will simply be written off. And the $400 million dollar investment will become worthless.

What makes all this so pertinent right now, is that all this has to be done in the next three weeks at the latest. You see, on December 31st the Fund will have its final valuation for the year.

This is the number that will go in their Annual Report. And the number that will be published to the world. But to arrive at the value of the overall fund, they must first calculate the value of those Evergrande Bonds.

Now in reality all this should be going on right now, to reflect an accurate Net Asset Value for the Fund. And that's why Friday's filing in Hong Kong becomes so very important. Now everyone, but especially the funds are on notice that Evergrande may indeed default.

So here's how you can find out if your investments will be affected.

It's really very easy. Simply search for your “Fund's Holdings” As memory serves, each quarter investments funds report on the stocks and bonds that they've invested in at the end of the quarter.

If you see Evergrande Bonds in that list, try to determine whether it's a substantial position for the fund. Representing a large investment, or not. It seems insignificant, and a loss here wouldn't really affect the overall performance of the fund, you can probably just ignore it.

But if the Evergrande Bonds represent a large proportion of the fund, you may consider selling the fund.

If you are looking at selling, you can rest assured that you won't be alone. Investment advisors, financial planners, and others who manage individual portfolios are all going to be making this same decision before the end of the year.

Absolutely no one will want to hold this hot potato when annual reports are made, and their performance is measured.