The political tension between China and Japan cannot be dismissed when it comes to the decision behind the world’s largest pension fund to shun Chinese government bonds, according to some experts.

Japan’s $1.7-trillion Government Pension Investment Fund (GPIF) has decided to exclude CGBs from its foreign bond benchmark, the FTSE Russell World Government Bond Index (WGBI). The WGBI is set to include CGBs starting end-October, over a three-year period.

Incorporating CGBs into GPIF’s portfolio will pose large risks, with settlement issues and limited liquidity for a fund with such a large investment scale, President Masataka Miyazono said during a July board meeting, according to minutes released in late September.

Dong Chen,
Pictet Wealth Management

A POLITCAL MOVE

“I think the reasons [GPIF cited] are irrelevant. I think it’s a political decision rather than a regular decision based on investment [strategies],” said Dong Chen, Hong Kong-based senior Asia economist at Pictet Wealth Management.

Thu Ha Chow, a Singapore-based portfolio manager for emerging markets debt at American asset manager Loomis Sayles, agreed that politics "is always in the background" when it comes to a big investment decision like GPIF’s, noting that geopolitical tensions would affect clients’ investment strategies, as they affect a country’s attitude towards foreign investors.

Chen noted that Donald Trump had directed federal pension funds to halt investment plans in China while he was in the White House. Given current China-US tensions, China’s diplomatic relationship with Japan, an important ally of the Biden administration, would be relatively difficult, Chen remarked.   

China used to be the biggest foreign holder of US Treasuries, with holdings of as much as $1.3 trillion. The positions were gradually cut after 2018 to stand at around $1.06 trillion currently. On the other hand, Japan has replaced China to become the largest US creditor since June 2019. It now holds $1.28 trillion in US sovereign papers.

“I believe [this] partly reflects a difference between China and Japan in their relations with the US,” Chen said.  

In response to AsianInvestor, a GPIF spokesperson denied any connection between the decision and the ongoing drama surrounding indebted Chinese property developer Evergrande Group. The spokesperson did not comment on whether any political consideration was behind the decision.

As of the end of June, 24.7% of GPIF’s assets, or $425.7 billion, were in foreign bonds.

Data as of March 31. Source: GPIF (Click for full view)

CHANGING WINDS

China’s bond market is much more open than it used to be, and there are essentially no more restrictions for interested foreign institutional investors, especially for a giant pension fund like GPIF – thanks to factors like the relaxed Qualified Foreign Institutional Investor (QFII) regime and the launching of the Bond Connect scheme in 2017, Chen noted.

As of the end of August, foreign institutions held Rmb3.58 trillion ($555.6 billion) of onshore Chinese bonds, rising 38% year-on-year, accounting for 3.8% of total Chinese bonds. Out of the Rmb3.58 trillion, Rmb2.2 trillion were in Chinese government bonds, according to China Central Depository and Clearing (CCDC).

“Foreign investors’ holdings of CGBs are increasing steadily,” Chen said. “As the world’s second-largest bond market [with over $18 trillion in size], I don’t see any liquidity issues, especially [for] sovereign debt,” Chen said.


 

Fund managers told AsianInvestor that it used to take foreign investors over a year to complete the full trade and settlement process setup for CGBs. In recent years, the time has been significantly reduced to less than two months, although this is still longer than the few days in some developed markets.

The current China 10-year government bond yield is 2.9%, while the US 10-year Treasury yield sits at 1.6%. The Germany Bund yield meanwhile is at -0.15%.

Thu Ha Chow,
Loomis Sayles

A CAUTIOUS APPROACH

Japanese institutional investors, especially in the public sector, tend to be more cautious in nature, Chow noted. GPIF’s decision was just bad timing, she believes, citing all the risks and uncertainties that emerged from China’s slowdown, the Evergrande incident, and the regulation overhaul in different sectors.

It’s also not unusual for conservative investors to refrain from becoming the first adopters after a bond instrument is newly included in a major index, she added.

“Hopefully over the long run, because China is such a big market, eventually some people will just come to accept [CGBs]. It just takes time,” Chow said.

Standard Chartered Bank estimated that passive inflows related to WGBI inclusion may be reduced to $2.9 to 3.6 billion a month from $3.6 to 4.3 billion, if GPIF is not part of it.

The impact on China’s sovereign debt market would be limited. If anything, the impact would be felt more in the Japanese public sector than in the private or global space, Chow said.

Diego López, Global SWF

Currently, the WGBI is used exclusively by Japanese investors as a benchmark, partly because it is used by GPIF, while the Bloomberg Barclays index is more widely used by global investors, GPIF noted in its board meeting.

Furthermore, CGBs’ inclusion into the WGBI is over a three-year period, thus GPIF believes its decision not to invest in something it hasn’t set foot in would have a minor impact on the market.

As of the end of March, GPIF’s exposure to Chinese bonds was minimal at $163 million, including $54 million in Evergrande, which represented 0.04% of its foreign bond portfolio, and 0.01% of its total $1.7 trillion assets under management, noted Diego López, managing director at Global SWF, a data tracking platform of global sovereign wealth funds and public pension funds.

“I wouldn’t say it (not to invest in CGBs) is a change in strategy or policy, but a continuation of what they were already doing,” López said. “If we are talking about reducing the exposure to China overall – where GPIF has a $19.1 billion in Chinese listed equities, and 22% of its small private equity portfolio, that’d be a whole different story altogether.”

“But as it is now, I am not sure that there is any [new] political consideration, or that it will affect the bond market or GPIF’s return in the foreign bond portfolio,” he said.