Attracted by yields and diversification potential, international investors have awakened to the opportunities Chinese local currency bonds offer. In 2020, total trading volume in the onshore market reached RMB241 trillion ($37 trillion) -- a record high.1 Yet questions remain over how global investors can best gain exposure to this rising asset class.
Satisfying yield-starved investors
With its A+ sovereign rating, positive currency outlook and yields of over 3%, Chinese government bonds (CGBs) are seeing increased demand, especially after being included into major bond indexes.2 As of end of February 2021, 10-year CGBs offered 80 basis points (bps) over 10-year US Treasuries, if hedged back to the US dollar. The yield pick-up against other major currencies such as the Japanese yen (JPY) and the euro (EUR) are 98bps and 114bps, respectively, on a fully hedged basis.3
Despite the improving economic outlook, we don’t expect the People’s Bank of China to cut rates in the medium term. Thus, we believe CGBs will continue to offer attractive yields vis-à-vis other major sovereign bonds in the coming years given the interest rate differentials.
On balance, the correlation of CGBs with other major sovereign bonds has been low, making CGBs an attractive diversifier in a global portfolio. We believe the potential steepening of the US Treasury curve will have limited impact on CGBs.
CGBs offer higher yields than major developed market bonds after hedging costs
Source: Bloomberg, PineBridge Investments as of 26 February 2021. For illustrative purposes only. We are not soliciting or recommending any action based on this material.
CGBs have historically low correlations and volatility versus developed market peers
Source: Bloomberg, PineBridge Investments as of 31 December 2020. For illustrative purposes only. We are not soliciting or recommending any action based on this material. UST = US Treasury, JGB = Japanese Government Bonds, and EGB= European Government Bonds.
Credit bonds: looking beyond the label
With RMB39 trillion in outstanding credit bonds,4 the credit market easily eclipses the Chinese credit opportunities represented in the JP Morgan Asia Credit Index (JACI) at $608 billion.5 China’s credit market has idiosyncratic characteristics not found in other major fixed income markets.
First, more than 60% of the bonds outstanding are domestically rated AAA.6 Despite being a highly rated credit market in a domestic context, underlying credit conditions show substantial diversification, which warrants an intensive and vigorous bottom-up credit process to identify gems and avoid undesirable credit exposures.
Secondly, a substantial portion of credit bonds are issued by government-related entities, largely local government financial vehicles, which generally finance, invest in and operate public infrastructure projects on behalf of local governments. However, the relationship between government-linked issuers and their sponsors has been evolving, with the implicit guarantee now less iron-clad than previously assumed as recent state-owned enterprise defaults demonstrate. This changing dynamic could yield opportunities for investors who are focused on credit differentiation among the different types of government-linked issuers.
Clearly, the opening of China’s onshore bond market marks, potentially, a once-in-a-lifetime opportunity to access a wide range of yuan-denominated bonds and be rewarded with attractive risk-adjusted returns. Nevertheless, we emphasise that the key to success in this market include research, proximity and flexibility. We believe investors will be better rewarded by working with Asian fixed income specialists that can swiftly identify and address trends and market-moving events to capture opportunities wherever they arise.
To learn more about opportunities in China’s onshore bond market, read our paper at pinebridge.com*
1. WIND, Bloomberg as of 31 December 2020
2. Bloomberg, PineBridge Investments as of 26 February 2021
3. Bloomberg, PineBridge Investments as of 26 February 2021
4. WIND as of 31 December 2020
5. J.P. Morgan as of 31 December 2020
6. WIND as of 31 December 2020
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