What Does Evergrande’s Collapse Mean for Your Portfolio?

What Does Evergrande’s Collapse Mean for Your Portfolio?

Today, China Evergrande Group defaulted on its $305 billion debt. The default has triggered churn in global markets, with investors anxiously awaiting the fallout. Here’s how we got here and what the collapse means for your portfolio. 

What Is Evergrande?

Hui Ka Yan founded Evergrande, formerly known as Hengda Group, in 1996 in Guangzhou. In 25 years at the helm, he has grown the real estate development group into a global power. According to the company website, it owns 1,300 projects in more than 280 cities. 

Evergrande does more than build real estate. It has investments in electric vehicles (Evergrande New Energy Auto), a theme park (Evergrande Fairyland), a soccer team (Guangzhou F.C.), and a food and beverage company (Evergrande Spring.) In total, Evergrande has 2,000 subsidiaries in China and 2 trillion yuan in assets, which accounts for 2% of China’s GDP. 

When Did the Trouble Start?

The first sign of trouble came in 2020. Evergrande contacted the Guangzhou government, saying it did not have enough liquidity for an upcoming payment in January 2021. As a result, the company's stock and bonds prices took a sharp downturn. A group of investors helped avert a crisis by temporarily waiving Evergrande’s $13 billion payment. 

However, the trouble didn't go away. Even though the company has considered selling various investments, none of these options offer a permanent solution. 

At this point, a government bailout would appear to be Evergrande’s best option. However, this path poses a thorny issue for the Chinese government. On the one hand, a bailout would limit the damage of the collapse on financial markets and Chinese homeowners. On the other hand, it would force the government to publicly support Evergrande’s reckless borrowing. 

How Will This Default Impact Global Markets?

Evergrande’s default is going to have an impact. The question is, how big? Banks, homeowners, suppliers, and investors are already bracing for a financial hit. 

The key is whether this collapse triggers a “cross default,” where it has a ripple effect on the global economy. Because Evergrande can't meet its debt obligations, it could extend to other commitments and contribute to a broader impact. According to Market Watch, the largest risk for “the U.S. would likely be a decline in the $120 billion worth of exports to China each year.”

We've already seen harbingers of investors' concern. The Dow Jones fell 600 points on Monday while the S&P 500 dipped 1.7%, its worst performance in months. Meanwhile, the Hang Seng index dropped 4%, with Hong Kong equities experiencing a significant sell-off. 

Why Does This Situation Sound Familiar?

If this situation sounds like a sequel to the 2008 financial crisis, you’d be right. Not only did a too-big-fail institution (Lehman Brothers) fail, but it also happened in September. Lehman Brother’s collapse triggered a global recession, and while experts don’t think Evergrande will have the same impact, it would be short-sighted to overlook the financial fallout.

The situation also draws parallels to the 1998 failure of Long-Term Capital Management L.P. The hedge fund had significant exposure to the 1997 Asian financial crisis and 1998 Russian financial crisis. The combination caused Long-Term Capital Management to lose $4.6 billion in less than four months and dissolve. 

How Can I Protect My Investments?

It's natural to wonder how you can protect your investments with an impending financial crisis. After all, no one wants to lose money. The answer lies in the market forces that influence the stock market, bonds, and mutual funds. 

Each of these equities responds to similar market forces. Changes in interest rates, dividends, corporate management, and company earnings can cause the price to rise or fall. During a bull market, equities overall increase in value, and everyone wins. 

During a bear market, we see the inverse. Equities decline in value and investors start getting worried. You’re not safe even if you have a well-diversified portfolio of stocks, bonds, and mutual funds. The aforementioned market forces impact each of these equities, so there’s no escape. 

So, what investments are not susceptible to the same market forces as traditional equities? Alternative assets. Alternative assets are anything other than stocks, bonds, and cash. Some examples include:

• Antique furniture
• Classic cars
• Cryptocurrency
• Fine art
• Fine wine
• Gold
• Memorabilia
• NFTs
• Silver

Let’s use fine wine as an example. It has a historically low correlation with the stock market, making it highly recession-resistant. That's because the actions of a company like Evergrande or Lehman Brothers have next to no impact on the wine industry. The value of wine depends on factors like annual harvest yields, reputation tariffs, consumer tastes, and the vintage. Barring a natural disaster or change in consumer tastes, fine wine will remain a steady and reliable investment. 

How Do Alternative Assets Perform During Recessions?

Time and again, alternative assets have handled recessions better than traditional equities. Frankly, the performances aren’t even close. They’ve done a better job of retaining their value during the Great Depression, Dot Com bubble burst, and more. 

For example, the S&P 500 sank 38.5% in the wake of the Great Recession. In the same span (2007-2008), the Liv-ex 1000 only dipped 0.6%. History repeated itself during the Covid-19 pandemic in 2020. The Dow Jones plunged 34.2%, while the S&P 500 dropped 22%. Meanwhile, the Vinovest 100 appreciated 1.1%. 

Fine wine and other alternative assets have defensive characteristics that make them ideal portfolio diversifiers. They benefit from stretches of economic growth while withstanding economic downturns. Silicon Valley Bank Wine Division founder Rob McMillian noted these characteristics in an interview with Forbes, saying:

“We have to start the conversation by recognizing that people enjoy wine in good times and stressful times. Wine is not recession-proof, but it is recession-resistant. In the same way, it might not be virus-proof, but it will prove virus-resistant from an economic perspective. There is no chance we will see sweeping abstinence as a consequence of the virus.”

Evergrande’s collapse is poised to create a domino effect in the financial markets. Investors are dealing with fear, panic, and uncertainty, with many people selling off to minimize their losses. Meanwhile, investors with alternative assets in their portfolios can breathe a little easier knowing they’re in an optimal position to weather the storm.