China Evergrande Fallout Hits Western Bond Funds

The potential default of real-estate developer China Evergrande Group is taking a toll on funds in Europe and the U.S. that chased high yields in the Chinese corporate bond market.

Concerns that Evergrande might not pay its bonds this month triggered selling of other companies in the country’s property sector, weighing down funds managed by Ashmore Group, BlackRock Inc. and Pacific Investment Management Co., among others.

While Evergrande bonds have been trading around 25 cents on the dollar for much of September, selling spread Monday to other large developers. Yuzhou Properties‘s 8.5% bond due in 2024 dropped about 10% to 75 cents on the dollar, according to Advantage Data Inc.

Fears of spreading fallout hit U.S. stocks and bond yields Monday, driving the yield on the benchmark 10-year Treasury note down to 1.308%, according to Tradeweb, from 1.369% Friday.

Western money managers increasingly purchased Chinese corporate bonds in recent years despite signs of a housing bubble. The buyers were looking for investments that paid more than the anemic yields in their domestic markets and could benefit from China’s high economic growth compared with developed markets. Many also believed that China’s government would bail Evergrande out if it foundered because of its size—the firm owed about $89 billion of debt as of June.

Some of the China bulls, like Ashmore, were emerging-markets specialists, but others were global-bond funds that traffic in developed and developing markets.

One of Ashmore’s larger funds lost about 1% last week and is underperforming comparable funds by 3.62 percentage points this year, according to data from Morningstar. The firm owned by U.K. financier Mark Coombs also performed poorly in 2020 after large bets in Argentina, Ecuador and Lebanon backfired in quick succession. Its stock has dropped about 20% this year, according to data from S&P Capital IQ. A spokesman for Ashmore declined to comment.

A global income fund managed by BlackRock lost about 0.31% last week and is lagging behind competitors by roughly one percentage point in 2021. The Ashmore fund was about 5% invested in Chinese corporates and the BlackRock fund had an approximately 7% exposure.

Worries may be overblown that default by Evergande could trigger a systemic crisis in China, much like Lehman Brothers Holdings Inc. did in the U.S., because other developers are functioning well, said Alan Siow, a portfolio manager at Ninety One.

“We don’t think Lehman is an apt analogy,” said Mr. Siow, who does not own any Evergande debt in his emerging-markets corporate bond fund and is focused on finding “companies that are best positioned to succeed in this environment.”

Distressed-debt hedge funds are also turning their sights on China’s corporate bonds, hoping to buy at bargain prices and to profit by restructuring the debt or by selling out when the broader market rebounds. “We’re doing a lot of heavy-duty work on [China],” said a portfolio manager at a New York-based fund.

A group of Evergrande bondholders formed a committee in recent weeks to create an organized negotiating block in restructuring talks with the company and the Chinese government, a person familiar with the matter said. Investment bank Moelis & Co. and law firm Kirkland & Ellis LLP are advising the group, the person said.