Pacific Investment Management Co. is favoring offshore bonds from Chinese issuers least affected by the slowest economic growth in a quarter century.

The extra yield on dollar-denominated notes from the nation’s borrowers over Treasuries has risen seven basis points this year to 277, the highest since October, according to Bank of America Merrill Lynch indexes. The cost of protecting Chinese sovereign debt from default spiked 20 basis points, the worst start to a year in data going back to 2008, as a weakening yuan triggered a selloff in developing-nation assets.

"We will have a more defensive strategy for China credits this year," said Luke Spajic, a portfolio manager in Singapore at Pimco. "We don’t expect to see much additional foreign demand for Chinese credits, given that there are other opportunities in both developed and emerging sectors that have cheapened significantly."

Data released on Tuesday showed China’s economy growing at two speeds, with old rust-belt industries from steel to cement in decline, while consumption, services and technology start to dominate. Though Chinese President Xi Jinping has welcomed the transition, he also needs to avoid runaway delinquencies, staunch a rout in equities and stem capital outflows that are weakening the yuan. Last year started with a default by property developer Kaisa Group Holdings Ltd. and ended with China Shanshui Cement Group Ltd. reneging on debt in November.

Economy Revamp

Pimco likes bonds from the services, Internet companies and non-cyclical industries, according to Spajic. The Chinese government is pushing to revamp the economy toward more sustainable growth driven by non-industrial sectors. Data Tuesday showed factory production increasing 5.9 percent in December from a year earlier, almost half the pace of the 11.1 percent jump in retail sales. Services accounted for 50.5 percent of output in 2015, the biggest component for the first time.

While the cooling economy has added to strains on corporate finances, growth at China’s level of 6.9 percent in 2015 still compares favorably to most other major economies globally, said Mark Reade, Hong Kong-based analyst at Mizuho Securities Asia Ltd.

Defaults Eyed

"Most Chinese dollar bond issuers are well-placed to weather slowing growth," Reade said. "A large proportion are state-owned enterprises which will continue to benefit from government support, while many others are property developers which are in decent shape due to rebounding contract sales and onshore bond market access."

China’s property companies have been taking advantage of falling onshore yields since authorities permitted them back into the local bond market in 2014 following a ban. A real estate recovery is spreading to more cities after authorities rolled out easing measures targeting regions with a surplus of unsold homes. New-home prices climbed in 39 cities in December, up from 33 in November, among the 70 cities tracked by the government.

As broader concerns in the nation’s credit markets linger, Western Asset Management Co. is preparing for the increased risk of defaults and volatility in the year ahead, said Desmond Soon, Singapore-based head of investment management in Asia outside of Japan. The company, which manages about $450 billion, is avoiding illiquid local-currency corporate bonds in Asia and favoring more active dollar notes from issuers that will have ready buyers for their assets in the event of non-payment.