Opinions vary widely about when Chinese bonds will be included in global fixed income indices, with forecasts ranging from three months to two years from now.
One of Fidelity International’s specialists has now contributed to the debate. Bryan Collins, portfolio manager for Asian fixed income, argues that a move by any of the main three bond benchmark providers – Barclays, Citi and JP Morgan – is unlikely for at least a year.
What is certain is that such a move will trigger big flows, as investors following those benchmarks will have to start allocating to mainland debt in line with the weighting the mainland is assigned within the indices. Indeed, foreign demand is already surging in anticipation of such a development.
Collins believes the most likely time frame for inclusion is 2018 onwards, and he also spoke to AsianInvestor about the widespread concerns over investing in onshore Chinese bonds.
“If we start to think about a time frame closer to the start of 2018, we’re going to most likely start to see inclusions of Chinese bonds in the commonly used government bond indices, perhaps in a staggered form and perhaps for some index providers but not others,” he noted. “I think then we will see a quite substantial pickup in the inclusion of bonds.
“Pretty much all of the index providers are looking at the Chinese bond market and considering what criteria would be needed for it to be included in the global indices, and when.”
Two of the three key criteria for inclusion have been met, said Collins: that the country in question must have both an investment-grade sovereign rating and a sufficient amount of bond issuance.
The other factor concerns accessibility to the market. The China interbank bond market (CIBM) and the new unrestricted way of accessing it – which will take six to 12 months to really ramp up – is likely to prove a significant development in meeting this final criterion, Collins said.
Some investors have been focused on the October 1 inclusion of the renminbi in the International Monetary Fund's special drawing rights basket of global reserve currencies, he noted. That was seen by many as a precursor to the development of the onshore bond markets joining global indices.
China debt concerns
Meanwhile, fixed income investors remain concerned among over issues such as the lack of corporate transparency in China, the expected rise in bond defaults, and onshore credit ratings not being aligned with international standards.
Moreover, China’s debt levels have reached alarming levels, argued the Bank for International Settlements (BIS) in a report in late September. For instance, the credit-to-GDP gap – the difference between the credit-to-GDP ratio and its long-term trend – stood at 30.1% as of end-March. A reading above 10% is a cause for concern, it said.
Collins was sanguine about these issues.
In respect of the BIS argument, he said: “China’s current debt levels are generally in line or even lower than a number of developed markets, yet offset by relatively higher levels of economic growth." He added that China’s absolute level of debt was largely concentrated in the government and state-owned sector, giving the authorities a high degree of control and thereby helping mitigate risks. This is a similar view to that propounded by Andy Rothman of US fund house Matthews Asia.
As for transparency around cost of funding, Collins argued that, if anything, it was increasing, given the steady growth in public bond issuance by corporates, governments, private and state-owned enterprises. In the past financing would largely have been done through bilateral loans from banks or other entities, he noted. “So the transparency of pricing of credit risk is actually increasing.”
When it comes to financial data available from corporates themselves, Collins conceded that the frequency and standardisation of results and audited information did not yet meet international standards. “That certainly warrants caution and careful research,” he said, hence the need for people on the ground.
Meanwhile, in respect of the mainland rating system, Fidelity’s application of its own credit research and rating methods is globally consistent, noted Collins. As a result, “the fact that there’s a difference between international and onshore credit rating agencies is neither here nor there”.
In respect of the potential for default rates to rise, he admitted they were “very benign” – at around 0.4%, based on Fidelity's estimate – and that the number of downgrades was rising. Again, he noted, this underlines the importance of staying close to the market by being on the ground.
Asked whether his firm planned to join the growing line of firms registering to invest in the CIBM, Collins was non-committal. “We are definitely interested but we need to go through the application process,” he said. “We’re exploring all of the options, and that’s an ongoing endeavour."
On a separate note, Collins said he did not see any imminent signs of Beijing launching the Bond Connect scheme, the fixed income equivalent of China’s Stock Connect link with Hong Kong.
Fidelity International has a team of around 10 research analysts covering debt and equity – including three credit analysts – in Shanghai across the rep office and wholly foreign-owned entity. It is working to build a local investment capability to service local investors and distribute locally managed products, said Olivier Szwarcberg, head of Asia fixed income.
“We believe, with the growth of the local pension and insurance market, Chinese institutional investors will increasingly allocate more assets into fixed income instruments,” he noted. "We are seeing the same trend for retail investors because of the volatility of the Chinese A-share market.”
The buildup in China is part of a wider drive by the firm – originally a subsidiary of US fund house Fidelity Management and Research but now an independent business – to at least double its fixed income assets in the region, as reported.