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A robust domestic debt capital market is imperative to the country’s economic growth, and Chinese policymakers aren’t ignorant of this. Over the past years, China’s bond market has shown impressive performance as it clocked in an annualised growth of 13% to $20 tn in 2022, states Blackrock. Currently, it is the world’s second-largest after the US.
Reforms in China’s financial markets and the inclusion of Chinese government bonds on some global indices were two key factors that boosted foreign participation in China’s bond market. According to FTSE/Russell’s latest White Paper, foreign ownership of Chinese government bonds has quadrupled in the last five years, from 2% to 8%. Overseas investors are entering through the direct route and China Bond ETFs. With the widespread acceptance of China bonds as a critical catalyst for a solid global fixed-income portfolio, this trend is likely to continue.
Understanding the Chinese bond market
Before delving into the current situation of the Chinese fixed-income market, here’s a quick look at its evolution and structure.
Post liberalisation in 1979, the Communist government issued its first bond in 1981. A national secondary market for trading these securities started in 1990, and since 1996, government bonds have been issued via an auction system.
There are three major bond markets: the China Interbank Bond Market (CIBM), Exchange Market, and the Over-the-counter market. Nearly 90% of all domestic bonds are traded on the CIBM which exhibits a strong trading volume. The securities traded on the CIBM and Exchange market include central government bonds, central bank bonds, policy bank bonds, financial bonds, medium-term notes, and commercial paper, as well as local government bonds.
Corporate bonds are only traded on the Exchange Markets. The rapid growth in issuance of corporate bonds in recent years has helped boost transaction volumes on exchanges.
China Bonds were the bright spot in Covid-19
The global economic meltdown due to the pandemic has established the appeal of the Chinese government and corporate bonds and the critical role that these play in an investor’s portfolio. 2020 was a turbulent year for global bonds, but at 3.3%, China’s sovereign bonds had one of the world’s highest total returns. Onshore (renminbi-denominated) Chinese corporate bonds were one of the only mainstream credit markets to yield positive returns during this period. On the other hand, Chinese government bonds offered investors the risk hedging risk-hedging benefits of a defensive asset.
Why are China bonds a compelling asset class?
Not just the pandemic, China bonds continue to offer better risk-adjusted yields even against the current backdrop of volatility and geopolitical upheavals. Here are a few of the reasons why investors are showing increased interest in this rapidly expanding market.
Better risk-adjusted yield
China’s bond market offers a relatively competitive yield per unit of volatility compared to other major fixed-income asset classes. China government bonds, at nearly 3.25% offer a return profile for investors, that has limited downside but a good price appreciation potential. Likewise, Chinese corporate bonds also provide attractive yields and wider spreads with lower duration risks when compared to other global credit markets.
According to the Bloomberg total return index, China’s government bonds were set to lose 8.5% in 2022, but it was better placed than US treasuries and UK Gilts with a 15% and a 26% downside, respectively.
The low correlation offered by Chinese bonds enables investors to reduce volatility, diversify their portfolio and earn alpha. A strong influence of domestic factors and not global events make a lower degree of correlation possible for the Chinese bond markets.
The US trade tensions and the rise of the Chinese middle class have led the Chinese economy to be a more domestic consumer-driven market. This also implies that China’s economic and monetary policy cycles are not perfectly aligned with other parts of the world but are influenced only by conditions emanating from China.
China’s bond market still has a strong local investor dominance, and this is what distinguishes it from most other emerging markets. Particularly, it makes China less vulnerable to external funding pressure and fluctuations in global capital flows.
Stability of the Renminbi
The Renminbi’s relative stability is another factor that favours the China bond markets. The Yuan was largely resilient throughout this pandemic compared to the currencies of some G10 and emerging market countries that fell sharply against the US dollar. Improved current account and a suppressed demand for global investors to drift away from the US dollar paves the way for a stronger Yuan in the long run.
According to Goldman Sachs Asset Management, “A narrowing of yield differentials with US Treasuries as a result of looser monetary policy in China compared to the US could put some downward pressure on the Chinese currency. But we believe the potential support of such a monetary policy action for the real economy and domestic assets should mitigate the impact on the renminbi.”
Low inflationary headwinds and government support
In sharp contrast to the US, the UK, and other major economies, inflation in China is relatively contained. Hence, the People’s Bank of China (PBoC) isn’t rushing to tighten policy. In fact, it is focused on lending support to the real economy. Thus, it has cut the reserve requirement ratio (RRR) for banks twice since December 2022 and announced a 10-bps cut to the one-year medium-term lending facility (MLF) and the 7-day reverse repo rate in mid-January 2022. Last year, the Chinese policymakers emphasised on “growth stabilisation” as their top objective.
China Bond ETF: A hassle-free access to the credit markets
One of the primary goals of the Chinese government is to emerge as a dominant player in the global fixed-income stage. The China Bond market offers a winning combination of attractive income and capital appreciation potential.
Though foreign ownership in this growing in China bond market, participation remains low. China is opening its financial markets to overseas investors and has launched several channels for their access to its credit markets. These include China Interbank Bond Market (CIBM) Direct, Qualified Foreign Institutional Investor (QFII) Scheme, and RMB Qualified Foreign Institutional Investor (RQFII) Scheme. The latest being is the Bond Connect programme launched in 2017, through which overseas investors can access fixed income markets in China via trading infrastructure in Hong Kong.
However, these programmes have a complex framework. Even for larger institutions, the path for the Bond Connect or related programmes can be quite cumbersome. Hence, China Bond ETFs can provide several benefits compared to the direct purchase of securities. It is one of the low-cost, transparent, and simpler methods of getting exposure to the Chinese fixed-income markets. These ETFs invest onshore and offshore to tap opportunities in China fixed income across duration and quality.
Standardised and simplified bond investing
China Bond ETFs trade on exchange and offer transparent pricing. It can act as a price discovery tool, that helps investors see how the value changes as it reacts to market movements.
Facilitates diversification and tactical portfolio allocations
China Bond ETFs allow quick and efficient implementation of asset allocation decisions. Investors can gain exposure to a wide range of bond markets by buying units of the funds and diversifying their portfolios.
Liquidity compared to direct transactions in the underlying bond markets
The ETF market offers an additional liquidity venue. The larger the China bond ETFs, the lower the bid-ask spread for the buyers and sellers.
Selected ETFs
VanEck China Bond ETF
VanEck China Bond ETF provides access to China’s onshore bonds and replicates the ChinaBond China High-Quality Bond Index. It has a total asset base of $37.8 mn and a net expense ratio of 0.51%. It holds a total of 72 bonds and has garnered a negative return of –4.45% over the past year.* It has a modified duration of 3.73 years and its Years to Maturity is 4.89.
The top holdings are China Cinda Asset Management Co Ltd with a maturity at 04/14/2027 (3.95%), ZIJIN Mining Group with a maturity of 02/21/2025 (3.80%), and Shandong Lucion Investment Holdings Group with a maturity of 01/07/2026 (3.80%) .**
iShares China CNY Bond UCITS ETF
The Fund by BlackRock has an asset base of $3 bn and tracks the BBG China Treasury + Policy Bank Total Return Index. It has an expense ratio of 0.35%. 51% of the holdings are Government-related while 48.67% are Treasury-backed. The iShares ETF garnered a negative return of 12.25% in the past year. It has an effective duration of 5.94 years and a dividend yield of 2.74%*
Goldman Sachs Access China Government Bond UCITS
This ETF by Goldman Sachs tracks the FTSE Goldman Sachs China Government Bond Index. It has an asset base of $182.7 mn and an expense ratio of 0.24%.
The fund has a duration of 5.7 years and has clocked in a negative return of 12.26% in the past year. 90% of the bond holdings are held by the Government of China. The current dividend yield of the ETF is 3.02%.**
*as of July 14, 2023
**as of July 13, 2023
