Despite its year-long trade spat with the US, China is continuing to open up its capital market, as was made clear by Beijing’s issuance of dollar- and euro-denominated government bonds in late November.
The latest $6 billion issuance – the biggest round by far for dollar treasury by China – came amid a slowing supply of traditional safe haven assets, such as US Treasuries, Japanese government bonds and German Bunds. Analysis by Oxford Economics shows that the growth in such safe assets is expected to fall behind that of global GDP.
But for asset owners whose portfolios mostly comprise fixed income assets, prevailing low interest rates have rendered the returns of safe haven assets unattractive. Yields on US three-, five-, 10- and 20-year US Treasuries, for example, stood at 1.61%, 1.62%, 1.78% and 2.07% as of the end of November.
As investors continue to hunt for better yields, China's newly issued government bonds could potentially help lift returns while broadening allocation options. The Chinese five-year dollar bonds were priced to yield 2.24%, close to 50 basis points over equivalent US Treasuries.
The question AsianInvestor asked investment professionals this week is: Are local and foreign currency-denominated Chinese government bonds likely to become safe-haven assets for investors, and an essential part of portfolios?
The following extracts have been edited for clarity and brevity.
Sandor Steverink, head of treasuries
APG Asset Management
You never know for how long a safe asset will be safe. A Treasury bond or a German Bund are now considered safe. APG always keeps looking for safe alternatives, especially if these alternatives have higher expected returns. APG considers Chinese bonds one of these alternatives.
We just started investing in Chinese bonds, and they are not an essential component of our clients’ investment portfolios yet. But we see the potential due to the size and the prospects of the Chinese bond market.
Since size is very important for a credit market to become a serious alternative, a more equal asset distribution across the three biggest credit markets (dollar, euro and renminbi) will [initially] be more likely [than Chinese bonds becoming an essential component of fixed income portfolios].
But that depends on a lot of other issues, of which responsible investing is a crucial one. This concept is new in China, but essential for global institutional investors.
[However, another factor here is that] the buying of bonds by central banks, and the consequent drop in bond yields, has increased the focus for investors to look for safe, better-yielding alternatives. Chinese debt markets have not been affected too much by the downward pressure on yields.
The repatriation hurdles that were removed recently in China were very important for foreign investors. What is still missing is an agreement between the Chinese regulators with their counterparts in other countries. That could increase the acceptance and liquidity of the Chinese bond market – and the speed at which it will professionalise.
Julio Callegari, portfolio manager for Asia local rates and FX
JP Morgan Asset Management
While Chinese government bonds may not intuitively seem to represent a major alternative for investors looking for safe-haven assets, it is very likely that the demand for Chinese bonds will increase appreciably in coming years.
Although China is the second-largest economy and the world's largest exporter, the share of Chinese government bonds in global portfolios today is almost irrelevant. But this is starting to change with the recent inclusion of China in key bond indices and should continue with the growing participation of foreign investors in the onshore market (offshore issuance – like euro-denominated bonds – is positive but should remain limited in size).
The key reasons underpinning this trend are related to the fact that Chinese government bonds are easier to access now via Bond Connect; represent a big and relatively liquid market (in fact the second-largest bond market in the world); are a source of diversification to global bond investors (exhibiting low correlation with other markets); and offer a higher yield versus US Treasuries.
It is also true that the ongoing trade tensions and China's economic deceleration imposes new challenges, but investors with expertise to navigate this dynamic market will be able to find relevant investment opportunities.
Irene Goh, head of multi-asset investing for Asia Pacific
Aberdeen Standard Investments
Given the inclusion of Chinese government bonds (CGBs) into major global indices and low foreign ownership, we expect CGBs to rise in prominence as a safe haven.
Firstly, CGBs still offer a 3% yield, while China has the highest sovereign credit rating (A+) among major emerging economies, courtesy of its stable domestic politics, sound financial system, strong balance sheet and large foreign exchange reserves.
Secondly, China’s economy is large and deep enough for its central bank to adopt a relatively independent monetary policy from developed peers. Low correlation with other bond markets enhances the diversification benefits of CGBs. When global government bonds sold off in 2018, CGBs hedged back to US dollars returned 8%.
Lastly, the accessibility of the CGB market and the cost of hedging renminbi risk have improved significantly for foreign investors in recent years. This further enhances its attractiveness as a safe haven.
Alfred Mui, head of Asian credit
HSBC Global Asset Management
The major rationale for China to issue foreign-currency debt is to provide a deep and liquid benchmark yield curve for other Chinese dollar and euro bond issuers. It also provides foreign-currency assets for its banks to allocate local deposits.
This is an attractive development for investors, as it gives a high quality, liquid asset with a decent spread against US Treasuries, while also providing an option for being defensive within an offshore China strategy. It should promote the further growth of the dollar and euro China credit market as it will make pricing more transparent and enhance liquidity. This will give Chinese issuers greater diversity of funding and support the stability of the Chinese economy.
This is a unique situation because never before has an economy the size of China's integrated into the global capital markets while also providing such liquidity – let alone as an emerging market. It is integral to the overall internationalisation of the Chinese financial system, which includes both greater access for offshore investors to China’s domestic markets, but also the potential to invest in offshore issuance of both the sovereign and corporates. This can only serve to give global investors greater portfolio diversification and a larger opportunity set.
David Chao, global market strategist for Asia ex-Japan
The global recession that many fixed income investors feared in 2019 – which pushed about a third of all fixed income products globally into negative-yielding territory – is dead.
I have argued throughout this year that this fear of recession has been substantially overdone. Despite worries arising from an inverted yield curve in the US earlier this year, the American economy is doing just fine with unemployment at historic lows, wages rising and continued strong consumer spending. Even the yield curve has steepened as the Federal Reserve continues to ease monetary policy.
I expect the fear of a potential global recession will subside – and in doing so, investors’ risk appetite will move out further along the risk axis, away from safe-haven assets such as gold, yen and negative-yielding sovereign debt.
Investors currently view Chinese bonds (that is, sovereign issues) as an alternative safe haven asset already, especially after the successful dollar and euro bond issues from the past few weeks that saw massive oversubscriptions.
More so, I think foreign institutional capital will start to add Chinese corporate bonds to their diversified portfolios for a couple of reasons. Firstly, as worries of a global recession subside, investors will take a more risk-on mode. Secondly, the recent structural changes to the Chinese bond market such as index inclusion and weighting increases will compel foreign institutional investors to consider a previously under-invested asset class. I expect to see healthy foreign fund flows into Chinese bonds over the next 12 months.
Joevin Chin-Ker Teo, head of Asian fixed income
We see recent issuances of Chinese hard-currency sovereign bonds in dollars and euros as a very positive development for the market. Global investor portfolios are still largely denominated in hard currencies. China's recent issuance thus gives more investors greater ability to express a view on Chinese markets by increasing their overall portfolio's China exposure in a straightforward manner.
Looking ahead, investor interest is likely to continue. Chinese hard-currency sovereign bonds are likely to make up an increasingly large portion of global bond indices. Increased hard-currency issuance along the curve will allow investors to express their views on duration.
At the same time, there is also the potential for more asset owners to improve their internal risk scores of Chinese hard-currency sovereign bonds; this will allow them to act as a complement to existing sovereign issuer exposure in their portfolios.
Finally, investors in Chinese hard-currency sovereign bonds will also benefit from the increased level of access to onshore government entities during investor roadshows. This will continue to enhance investors' understanding and appreciation of Chinese market dynamics.