Suffice it to say David Tawil, co-founder of Maglan Capital, is not a China bull.

Avoid China’s bond market as government intervention and debt restructuring presents risks

The New York-based hedge fund manager, who invests in companies struggling to repay their debt, says investors should avoid China’s bond market in the wake of the Asian nation’s first default due to government intervention and debt restructuring could lead to losses.  The best way to profit from distressed companies in China is to sell listed stocks, he advised, according to a letter to investors reviewed by ValueWalk.

maglan-capital Chinese Debt

“In China, government involvement is much more pervasive, especially in industries like banking and real estate,” Tawil was quoted as saying in a Bloomberg report.  “The only way to play the distressed cycle is shorting equities. The problem in fixed income is, I don’t know if the bonds are going to drop, and even if they do drop, the government may come in and rescue them.”

With $70 million under management in the Maglan Distressed Fund, former Credit Suisse Group AG (ADR) (NYSE:CS) leveraged finance bankers and debt restructuring lawyers Tawil and partner Steve Azarbad founded the fund in 2010.  The fund is up 10% year to date and delivered a 59% return to investors in 2013.  Maglan does not have any short positions in China yet, but Tawil was quoted as saying he’s eying shorts in interest rates and real estate, and thinks metal producers and some lenders are weak.

China issues

China has experienced a spat of defaults as the once-communist stalwart struggles to find the right recipe for its version of controlled capitalism.

China faced a major decision when China Credit Trust Co. was bailed out in January, unable to make bond payments.

Then a firm in a strategic industry defaulted.  Shanghai Chaori Solar Science & Technology Co., in solar-cell manufacturing, missed part of a bond-coupon payment that was due March 7.  Chaori Solar’s bondholders are considering a lawsuit to recover their money as they eye their investment cut by nearly 40%. Chaori sold 1 billion yuan of five-year securities at par in March 2012. Investors in those notes have taken a hit, as they were at 57.44 percent of face value on March 24, according to the report. This was not the first problem in China’s solar industry.  Suntech Power Holdings Co., Ltd. (ADR) (OTCMKTS:STPFQ), once the world’s largest solar-panel maker, defaulted on $541 million of convertible notes last year as it files for U.S. bankruptcy protection in February.

Tightly held Zhejiang Xingrun Real Estate Co. imploded March 17 it didn’t have cash reserves to repay 3.5 billion yuan ($565 million) of debt.  The migration of China’s population to urban centers has created an overheating of that economic sector, creating imbalances.

While the Chinese government expresses concern about US government debt being paid in the long term future, the world’s second largest economy has more immediate problems at home. Hinting at future issues for investors, Premier Li Keqiang said this month defaults may be unavoidable in some cases.

Maglan Capital returns

Maglan Capital is having a stellar year. The hedge fund is up over 10.4% through the end of February. This follows a very impressive 58% return generated in 2013.