Being exposed on Chinese bonds makes sense

The market is opening up to international investors, and flows have been increasing rapidly since the start of the year.

Over the last 10 years, China has become the third largest bond market in the world (behind the United States and Japan) and the largest single country in the EM hard currency universe. Furthermore, Chinese bonds represent more than 50% of the Asian USD credit markets . « China is likely to overtake Japan at some point in the close future », points out Roy Diao (Head of Asian  Fixed Income at Schroders). « Just like with equities, the Chinese bond market is going to benefit from its inclusion in the global bond indexes. Barclays has started to include Chinese bonds in their indexes in 2019 and I am hopeful that the other providers (JP Morgan, FTSE) will follow at some point in the not too distant future ».

Dispersion

Roy Diao believes that the outlook for the Chinese domestic bond market remains quite positive, with the central bank having lots of room to cut their benchmark interest rate in the coming quarters. « For active investors, there are lots of opportunities with wide spread dispersions. Onshore Chinese government bonds are inefficiently priced compared to developed markets. Similarly, there is a much wider credit spread differential on similarly rated companies within the same sector ». 

He also points out that with monthly issuances, the liquidity on the sovereign bond market tends to fall quite rapidly. « The secondary market is very narrow, but with more institutional players getting involved, I believe we will potentially get better liquidity on the market.» He adds that the composition of the Chinese bond market is similar to the other major bond markets, with diversity across sectors and alpha opportunities. 

Diversification

Roy Diao underlines the advantage to have a part of your portfolio exposed on the Chinese bond markets. « We have been backtesting the benefits of adding Chinese bonds in a global diversified portfolio.   China is still a semi-controlled bond market and is, therefore, going to have a very low correlation with developed markets. The study suggests that a 15% exposure is the most efficient way to add diversification with Chinese bonds, and that it is at least worth investigating for a global bond investor ».

« Still, international investors represent only 1, 6% of the market as it is  quite cumbersome to enter the market ». But this is changing, with massive inflows (31 billions dollars in 2019) going into the domestic bond market. « More and more institutional investors? are trying to get exposure despite the trade dispute, due to the inclusion of CNY bonds in the fixed income indexes ». And even if they stay underweighted compared to the benchmark, this should still imply significant inflows to the Chinese market going forward.

Credit ratings

China is also getting more and more present on the Green Bond market, mainly through issuance by financial companies. « They use the proceeds to finance green projects, but the definition of a Green Bond in China is currently not comparable to the definition in the developed markets. We expect to have more alignment with the international standards going forward ». Regarding ESG criteria on the corporate bonds markets, he points out that the main focus is currently set on the governance issues. « State owned companies are not as open and transparent as private companies, and they are not accustomed to disclosing details regarding an issue. Our bottom-up due diligence is a important input for our analysis.  ».

On the credit market, there is also a misalignment of the domestic and international credit agencies. Corporate bonds issued in dollars are all rated A or below by international agencies, but 90% of the onshore emissions in CNY are rated above AA by domestic rating agencies. « This requires us to do our own homework when analyzing investment opportunities, but this fits perfectly with what we are used to doing ». Schroders is expanding its credit analysis resources in Hong Kong and Shanghai to cover more domestic Chinese opportunities. Roy Diao also points out that changes in the regulatory environment are happening on a regular basis, which imposes a good understanding of the different regulatory bodies operating on the market.  « To invest on the market, you need to be able to execute the deals ».

Important Information
The views and opinions contained herein are those of the author and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.
This article is intended to be for information purposes only. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. Reliance should not be placed on the views and information in the article when taking individual investment and/or strategic decisions.
Past performance is not a reliable indicator of future results, prices of shares and the income from them may fall as well as rise and investors may not get back the amount originally invested.
Schroders will be a data controller in respect of your personal data. For information on how Schroders might process your personal data, please view our Privacy Policy available at www.schroders.com/en/privacy-policy or on request should you not have access to this webpage.
Issued by Schroder Investment Management (Europe) S.A., 5, rue Höhenhof, L-1736 Senningerberg, Luxembourg. R.C.S. Luxembourg: B 37.799.
For your security, communications may be taped or monitored.
The forecasts stated in the article are the result of statistical modelling, based on a number of assumptions. Forecasts are subject to a high level of uncertainty regarding future economic and market factors that may affect actual future performance. The forecasts are provided to you for information purposes as at today’s date. Our assumptions may change materially with changes in underlying assumptions that may occur, among other things, as economic and market conditions change. We assume no obligation to provide you with updates or changes to this data as assumptions, economic and market conditions, models or other matters change.
 

 

Contact Schroders

Schroders is a world-class asset manager operating from 32 countries across Europe, the Americas, Asia, the Middle East and Africa.


Worldwide locations

For any further questions, please use our online contact form.

Contact form