Chinese bond funds are set to drive the growth of the mainland investment industry in the coming two to three years on the back of institutional demand, argues an analyst with credit rating agency Moody’s. 

Hong Kong based Nino Siu said the main reasons for greater foreign interest were China’s interbank bond market (CIBM) opening up and the renminbi’s inclusion in the International Monetary Fund's special drawing rights currency basket.

Global uncertainty – further exacerbated by Britain's June 23 vote to exit Europe – and continued low interest rates will also contribute to appetite for fixed income.

Another important factor will be the country’s National Social Security Fund (NSSF) handing out more bond mandates in the coming three years, said Siu. 

The fund more than doubled in size to Rmb1.9 trillion ($286 billion) as of end-2015, from Rmb869 billion at end-2014 and is expected to be handed as much as Rmb2 trillion to manage in the coming years as a result of China's public pension fund reform

NSSF has increasingly outsourced investments to fund managers in the past five years, with external firms running 54% of its portfolio last year, up from 42% in 2011, he noted. This trend is set continue, as the government relaxed rules in April 2015, allowing the fund to allocate 20% to domestic corporate debt and government bonds, up from 10% previously. 

Moreover, NSSF reduced its foreign exposure and boosted its roster of domestic asset managers last year, as reported.

Overall, China-based mutual funds invested $122 billion in their local bond market – the world’s third biggest – as of March. Siu said commercial banks were the most active players, accounting for 58% of bond holders, while fund managers accounted for 19%

China bond fund assets under management grew 20% to Rmb938 billion ($141 billion) in the first quarter, even as the overall industry shrank 6% to Rmb7.58 trillion, according to the China Securities Regulatory Commission.

And foreign investment into mainland debt is only set to rise once the CIBM adopts higher standards of governance and transparency, following the February move to do away with the quota system. This jas been followed by clarification of the rules on capital remittance, Singapore becoming the first central bank to include RMB within its official foreign reserves, and the first foreign fund house, Insight Investment, registering to enter the CIBM.

China balanced funds are also likely to attract more flows, noted Siu, as retail investors are moving assets from savings to investment, and institutional investors are allocating more to such strategies amid weak market sentiment. A key reason for this is that 99% of guaranteed funds in China are categorised as balanced funds, he added. 

Overall, Chinese asset managers launched 116 bond funds and 63 guaranteed funds in the first half of 2016, raising Rmb109 billion and Rmb147 billion, respectively. These products accounted for 72% of the Rmb356 billion raised by 355 new launches in the period, according to data provider Wind.