China’s evolving bond market

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. The investor may not get back the amount originally invested.

 


Ignoring the rapidly changing ecosystem could be costly

China’s bond market ascent to second largest in the world was driven primarily by local investors. The next leg of growth should be more diverse in ownership and characterised by closer alignment with international standards. Flagship global benchmarks for stocks and bonds are stepping up or initiating representation of Chinese securities. As a result, capital is in flux and investors are rethinking global allocations, but many questions remain, including:

  • Why own Chinese bonds? – Incentives include potential benefits from diversification and relative valuations, as well as benign fundamentals and global recognition facilitating flows.
    Risk: Diversification and asset allocation may not fully protect you from market risk.
  • Who can buy Chinese bonds and how? – Onshore Chinese bonds are open to foreign ownership through various channels and access has progressively become easier.
    Risk: Investments in China are subject to certain additional risks, particularly regarding the ability to deal in equity securities in China due to issues relating to liquidity and the repatriation of capital. As a result, the Fund may choose to gain exposure to Chinese equities indirectly and may be unable to gain full exposure to Chinese equity markets.
  • How could investors address opportunities / risks? – Forming macro views is critical to create yield curve scenarios. Also, credit bonds may offer significant opportunity for alpha generation, but demand in-depth credit analyses.
    Risk: While the investment approach described herein seeks to control risk, risk cannot be eliminated.
  • What other considerations matter? – Unlike most bond markets, Chinese bonds are driven primarily by internal factors. This may lead to uncorrelated returns but understanding internal issues and overcoming risks is critical.
    Risk: There can be no guarantee that the investment strategy can be successful and the value of investments may go down as well as up.

The ongoing inclusion of Chinese bonds in the global indices has brought this market to the forefront of investors’ minds. We believe this is one more step along a continuously and rapidly evolving market. Ignoring it could be costly, especially over the longer term.

Any opinions, forecasts represent an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research, investment advice or a recommendation.

Why own Chinese bonds?

China has the world’s second largest bond market1 , economic growth albeit slower is still vibrant and policies are favoring external financing. Other reasons include:

Fundamentals –Countercyclical easing is supporting China’s growth, and we have a constructive view on the yuan. We believe greater credit differentiation of Chinese bonds will multiply opportunities for active credit selection.

Diversification –Chinese bonds have offered higher yields than other major bond markets, low correlations to global fixed income and a large credit universe.2

Relative valuation –The unsynchronised U.S.-China policy cycle may create potential cross-border arbitrage and tactical allocation opportunities.

Global recognition –In April 2019 the inclusion of China’s government and policy bank bonds in the Bloomberg Barclays Global Aggregate Index acknowledges China’s steps toward a mature financial market and facilitates inflows.

1 Source: WIND October 2019
2 Source: Bloomberg 2019

China's three main bond markets

China’s bond market may be confusing because there is not one but three markets: one onshore and two offshore (see table below). Also, the onshore market is really two markets: the China Interbank Bond Market (CIBM) and the exchange market. The two differ in size, ownership and types of bonds traded. The CIBM, by far the largest (~90%), is dominated by institutional investors and covers most of the rates bonds (the government issued bonds). The exchange market, the remaining 10% of the total onshore market, is dominated by retail and small institutional investors and consists primarily of corporate bonds. Accessibility is improving, and policymakers are more open than ever to move closer to international standards as evidenced by the removal of Renminbi Qualified Foreign Institutional Investor (RQFII) / Qualified Foreign Institutional Investor (QFII) quota limits by the government in September 2019.

The Chinese onshore market has a large credit universe and has shown low correlations with other major bond markets1. This may provide opportunities for alpha generation and may diversify a global bond portfolio. Also, we see greater credit quality differentiation becoming a major driver of future alpha-generating potential, albeit this will be proportional to research quality and knowledge of credit issuers.

China's three main bond markets

For illustrative purposes only. Source: BlackRock, as of September 2019.

Notes: 1BlackRock, August 2019. 2Renminbi Qualified Foreign Institutional Investor & Qualified Foreign Institutional Investor. 3Wind, as of June 2019.

How can foreign investors access Chinese bonds

Currently, foreign investors can only access the China onshore bond market through offshore funds. Foreign institutional investors can utilise three distinct channels to access the onshore market. Bond Connect, via Hong Kong, is the simplest and most flexible. This explains its recent surge in popularity relative to the other two access channels.

How can foreign investors access Chinese bonds

For illustrative purposes only. Source: BlackRock, as of September 2019.

1Renminbi Qualified Foreign Institutional Investor. 2China Interbank Bond Market Direct. 3Central Moneymarkets Unit, a computerised clearing and settlement facility of the Hong Kong Monetary Authority. Diversification may not fully protect you from market risk.

Note: CNY is the currency symbol traded onshore, mainland of China. CNH is the currency symbol traded outside of China.

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