Index providers “under pressure” on China bond inclusion

China's bond market is likely to be included in global fixed income benchmarks next year, but investors remain cautious on mainland debt securities, says Pimco's Luke Spajic.
Index providers “under pressure” on China bond inclusion

Chinese onshore bonds are likely to be included in global fixed income benchmarks next year, as index providers are “under pressure” to make this move, according to a senior executive at US fund house Pimco.

“My suspicion is that 2017 [will be] a major turning point,” said Luke Spajic, Singapore-based head of portfolio management for emerging Asia. He had previously expected this to happen in 2018, but has revised his thinking given the speed of opening of the China interbank bond market (CIBM).

Pimco has not yet entered the CIBM, but most debt investors will be forced to participate once it becomes part of international benchmarks, noted Spajic.

Flows are only likely to ramp up substantially when this happens, he said, when asset managers will have spent time studying and analysing the details around settlement, counterparties and the like.

Currently investors are concerned that the renminbi will weaken further and hedging out that currency risk could cost up to 2.5%. That would almost cancel out the 2.8% yield offered by 10-year China government bonds.

What’s more, foreign investors hold a very cautious long-term view on mainland bonds because of short-term developments and changes in policy by Beijing, said Spajic. Investors need to ensure capital can enter and exit China seamlessly, he added.

There are also other issues preventing greater inflows, including worries around market transparency, governance and rating standards, as noted.

Asset managers have been eyeing the possibility of China bond inclusion since March, one month after the CIBM opened further to foreign investors.

JP Morgan’s emerging-market government bond index (GBI-EM) is likely to be the first benchmark to include China bonds. It started reviewing the CIBM for inclusion in March, but has not given any indication of a time frame for when that might happen. Onshore renminbi bonds are expected to account for a 10% weighting in the GBI-EM index, which is tracked by $180 billion of assets.

The “benchmark effect” would see substantial flows into Chinese bonds, citing a similar change in South Africa in 2012, according to a Pimco research note. After South African bonds were included in Citi’s World Government Bond Index (WGBI) in mid-2012, the country’s $88 billion debt market saw $7 billion of inflows. Standard Life Investments has estimated there would be a $138 billion inflow into the CIBM, if it were included in the JPM GBI-EM and Citi's WGBI.

In another research note, Pimco said a 1% increase in a country’s weighting in a global benchmark, combining both equity and bond assets, on average results in a 0.7% rise in that country’s weighting in mutual funds following that index. 

Spajic said the CIBM opening was the most significant event in the history of capital markets. However, Pimco still has minimal investments in Chinese onshore bonds either through its $100 million in qualified foreign institutional investor (QFII) quota or its Rmb1.8 billion ($269 million) in renminbi-QFII quota. but he declined to provide a specific amount.

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