Releasing China from its bonds – the Chinese fixed income market opens up

China’s bond market is opening for business

What is it about the second biggest bond market in the world that means it tends to fly under the radar? It’s certainly not its size at $17.5 trillion.1 It may, however, be that it has historically been closed to foreign investors. But all that is changing.

The market is opening up and major benchmark providers – including Bloomberg, FTSE and JP Morgan – are incorporating onshore China bonds in their global indexes for the first time. Through Exchange Traded Funds (ETFs) alone, this move could see significant foreign inflows. After all, increasing ease of access has already brought more than $500bn of foreign capital into onshore China bonds – more than half of which has flowed in since 2019.2But with 97% of the market still being owned domestically, these numbers could soar in the months and years ahead.3

As investors, it often feels like we are forever playing catch up when it comes to China’s progress and possibilities, the magnitude of its growth and improving quality. And, given the changes that are afoot, we may all be about to see the China’s bond market’s true potential.

A unique opportunity?

China bonds have a low correlation to the total returns of developed market bonds, offering significant diversification across the credit and duration spectrum. When bond markets around the world were rocked by the beginning of the Covid-19 pandemic, China-based fixed income was relatively flat. The asset class is also offering higher yields than developed market debt at a time when the hunt for yield is high on the agenda for many investors. Today, half of all bonds that yield 2.5% or more – both government and credit – are in China.

China accounts for more than half of global bonds yielding more than 2.5% 

China fixed income

Source: WIND, BBGBarc Multiverse Index as of 31 March 2021.
1 Source: WIND, as of December 2020.
2Bloomberg and JP Morgan index inclusion have completed as of end 2020, with FTSE WGBI inclusion planned to commence in October 2021. Estimated inflows from three indices respectively are US$150bn, US$30bn and US$150bn respectively.
3Source: JP Morgan, WIND September 2020.

Investors can still get on at the ground floor

Increasingly accessible China bonds are offering today’s investors exciting new sources of yield and diversification, but the average allocation remains very low. Even compared to the average explicit allocation to Chinese equities – just 0.4% in 2020 – the average allocation to bonds is extremely small at a paltry 0.05%.1This amounts to a structural underweight exposure to China and, although many investors will not see it as such, they are taking an active position – one that could cost them relative returns.

In summary – a market that cannot be ignored

Though the numbers remain small compared to the size of the country’s market, China bonds are a growing component of global bond indices – investors won’t be able to ignore them for much longer. In fact, only US dollar, euro and Japanese yen denominated bonds are larger components of the Global Aggregate Bond Index.

If you are comfortable with the political risks that may come with exposure to Chinese fixed income, the diversification benefits and potential for a higher yield are particularly attractive. This is a growing, open and increasingly high-quality and transparent market that we are going to be hearing a lot more about in the future.

1Portfolio average allocation figures based on BPAS EMEA client portfolios gathered between 31 Dec 2019 and 31 Dec 2020.

Risk Warnings

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1 Portfolio average allocation figures based on BPAS EMEA client portfolios gathered between 31 Dec 2019 and 31 Dec 2020.

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4 Portfolio average allocation figures based on BPAS EMEA client portfolios gathered between 31 Dec 2019 and 31 Dec 2020.

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