- CSOP Asset Management will be launching the ICBC CSOP FTSE Chinese Government Bond Index ETF – the first China-focused fixed income ETF in Singapore – for investors seeking to gain exposure to China’s massive onshore bond market.
- The ETF tracks the FTSE Chinese Government Bond Index, which measures the performance of fixed-rate government bonds issued in mainland China.
- With its ‘safe haven’ characteristics, decent yield, and low correlations with global bonds, fixed income investors can certainly benefit from an allocation to the onshore Chinese government bond market in their portfolios.
The fixed income investment landscape today is vastly different from that seen decades ago. Bond yields are currently at egregiously low levels, exacerbated by the current uncertainty in the global economic environment that has sent investors racing to the safer fixed income investments, as well as the low interest rates set by central banks over the past several years.
All is not lost.
For investors seeking a yield pick-up over the low-yielding developed markets, the upcoming ICBC CSOP FTSE Chinese Government Bond Index ETF will be an interesting addition to their fixed income portfolios, offering relatively higher yields and diversification opportunities.
The first China-focused fixed income ETF in Singapore
For many years, China’s onshore government bond market has been dominated by institutional investors, with retail investors largely excluded from participating due to access issues. While China’s presence in our portfolios has been increasing over the years, it is primarily via the equity markets.
With the aim of improving retail access to the Chinese onshore government bond market, CSOP Asset Management will be launching the ICBC CSOP FTSE Chinese Government Bond Index ETF – the first China-focused fixed income ETF in Singapore – for investors seeking to gain exposure to China’s massive onshore bond market. It tracks the FTSE Chinese Government Bond Index, which measures the performance of fixed-rate government bonds issued in mainland China.
The ETF adopts a representative sampling strategy, which means that it is not required to purchase all of the bonds represented in the index. Instead, the ETF may purchase a subset of the bonds in the index to construct a portfolio that generally has the same risk and return characteristics of the underlying index.
Making its debut on the SGX on 21 September 2020, the ETF is expected to have 20-40 holdings, offering investors an estimated yield-to-maturity of about 2.98%. The management fee is also expected to be at an affordable 0.25% per annum. The ETF is available in SGD (SGX:CYC) and USD (SGX:CYB) share classes.
China’s onshore bond market too big to ignore
Back in 2000, the size of China’s onshore bond market was just USD 286 billion. Fast forward to the present, the market is now worth USD 14.9 trillion in bonds outstanding as of June 2020. It is now the second-largest bond market in the world behind the US.
There are a wide range of issuers in China’s onshore bond market, ranging from the government, banks, to non-bank corporates (Chart 1). Within government bonds, there are distinctions made between bonds issued by the central government, local governments, as well as policy banks. Policy bank bonds are those issued by the China Development Bank, Agricultural Development Bank of China, and The Export-Import Bank of China, all of which are fully owned by the Chinese government to facilitate the implementation of certain financial policies.
The ICBC CSOP FTSE Chinese Government Bond Index ETF invests primarily in bonds issued by the central government.
Chart 1: Wide range of issuers in China’s onshore bond market
While foreign restrictions in the past have prevented foreign investors from investing in China onshore bonds, the launch of the Bond Connect in 2017, along with inclusion in major fixed income indices, has greatly enhanced access to and liquidity of the Chinese onshore market, with foreign participation picking up over the years (Chart 2). As of June 2020, foreign institutions held more than CNY 2.5 trillion of onshore China bonds, nearly 4 times the amount held in 2015.
Chart 2: Foreign investor interest in China’s onshore bond market has been picking up
Despite that, foreign investors still account for less than 3% of the total onshore China bond market. Given the size of China’s onshore bond market, improved market access, as well as inclusion in major fixed income indices, we expect investor interest in China’s onshore bond market to increase in the years ahead.
Higher yields relative to developed market government bonds
Since the global financial crisis, global central banks have embarked on aggressive (and sometimes unconventional) monetary policies to stimulate their economies. As a result, interest rates have been at extremely low levels, and in the case of Europe and Japan, at negative levels. The rush for safe havens amidst the COVID-19 pandemic this year has also driven the yields of global bonds to record lows.
While the yields of Chinese government bonds have also fallen, they remain higher than similar-tenured government bonds issued by developed economies (Chart 3). In fact, the extra yield pick-up offered by Chinese government bonds over US Treasuries has widened to almost 2.4 percentage points – that’s the biggest gap in nearly nine years. With the Fed expected to keep rates anchored at the low end for some time, the additional yield offered by Chinese government bonds looks even more attractive.
Chart 3: Yields on 10-year government bonds
Investors who have doubts over Chinese government bonds as a safe-haven instrument should note that China has a sovereign credit rating of A+ by Standard & Poor’s, equivalent to that of Japan (A+), higher than Italy (BBB), and only two notches below the UK and France. Its investment-grade credit rating lends support to the notion that Chinese government bonds are a stable investment.
Moreover, China’s government debt-to-GDP ratio remains low compared to most developed markets (Chart 4). With its economy also back on track following the fallout from COVID-19, the possibility of defaults remains remote at this juncture.
Chart 4: China’s government debt-to-GDP remains low relative to other developed economies
Chinese government bonds can provide diversification benefits
Adding further allure to the investment case is the fact that Chinese government bonds can provide diversification benefits to any global fixed income portfolio, given that they have traditionally exhibited low correlation with other fixed income markets.
Since 2009, the correlation between Chinese government bonds relative to global bonds has been low at 0.24. Furthermore, correlations with major regional developed bond markets (US, Europe, UK, and Japan) have also been low over the same period, ranging from 0.07 to 0.21. Even in comparison with emerging market local currency bonds, the correlation with China remains low at 0.29.
Table 1: Fixed income market correlation based on USD unhedged returns
|
China Government |
Global Aggregate |
US Government |
Euro Government |
UK Government |
Japanese Government |
EM LCY Government |
|
|
China Government |
1.00 |
| |||||
|
Global Aggregate |
0.24 |
1.00 |
| ||||
|
US Government |
0.07 |
0.42 |
1.00 |
| |||
|
Euro Government |
0.21 |
0.81 |
0.08 |
1.00 |
| ||
|
UK Government |
0.21 |
0.63 |
0.27 |
0.51 |
1.00 |
| |
|
Japanese Government |
0.15 |
0.43 |
0.52 |
0.25 |
0.26 |
1.00 |
|
EM LCY Government |
0.29 |
0.71 |
-0.06 |
0.69 |
0.42 |
0.12 |
1.00 |
|
Source:
Bloomberg Finance L.P., iFAST Compilations. From Mar 2009 – Aug 2020. |
|||||||
These historically-low correlations to other major bond markets suggest that Chinese government bonds can offer strong diversification benefits in global fixed income portfolios. As an example, Chinese government bonds were relatively insulated from global market shocks in the past, such as Brexit, and the US elections in 2016. Even amidst the unprecedented COVID-19 pandemic this year, Chinese government bonds were more resilient compared to global bonds through March and April (Chart 5).
Chart 5: China bonds held up well relative to global bonds during COVID-19 pandemic
The low correlation is largely due to fact that the performance of the Chinese government bond market is not so much driven by global events, but more by domestic factors, with China’s interest rate movements and monetary policy largely independent from the other major economies. Given the large local investor base in China’s government bond market relative to foreign investors, the market also tends to be driven by domestic investors’ expectations and demand.
While the correlation between Chinese government bonds and global bonds are expected to pick up as China opens up its financial sector, the market remains at the early stage of its global market integration, and should continue to provide attractive diversification benefits for investors.
Potential trade-offs to be aware of
Currency Risk: While China is the second-largest economy in the world, it remains an emerging market, which means that its currency is still subject to fluctuating investor sentiment and short-term volatility. For investors whose base currency is not the renminbi, investing in Chinese government bonds introduces significant currency risk i.e. it is possible for investors to see their returns from Chinese government bonds eroded by sharp movements in currency markets.
As currency risk introduces significant volatility into one's fixed income portfolio, it usually makes sense for investors to opt for currency-hedged share classes to reduce the risk of currency fluctuations eating away at their expected returns. However, while most actively-managed fixed income unit trusts offer SGD-hedged share classes, SGD-hedged fixed income ETFs are largely unheard of.
The ICBC CSOP FTSE Chinese Government Bond Index ETF does not come with a SGD-hedged share class.
Interest Rate Risk: In recent months, investors have turned to equities and shunned government bonds, often seen as a safe haven, causing their prices to fall and also pushing up yields on government bonds. Optimism over the current economic recovery has also led to expectations of tighter monetary policies.
When interest rate rises, the value of bonds in the ETF may fall, and this may result in losses on your initial investment. This is in contrast to holding an individual bond to maturity, when you will receive the full principal amount, eliminating any interest rate risk in the process. Bond ETFs, however, do not have a maturity date, and are at the mercy of interest rate fluctuations.
Not a must-have in all portfolios
To be sure, the ICBC CSOP FTSE Chinese Government Bond Index ETF is not a must-have in all portfolios.
While its estimated yield-to-maturity of about 2.98% is indeed decent compared to the low-yielding developed markets, it comes with a caveat that currency fluctuations may erode returns. Investors who are not comfortable with the currency risks involved should probably consider a SGD-focused fixed income ETF instead.
Nonetheless, for investors who are looking out for options to further diversify their global fixed income portfolios, they can consider subscribing to the ICBC CSOP FTSE Chinese Government Bond Index ETF. With its ‘safe haven’ characteristics, decent yield, and low correlations with global bonds, fixed income investors can certainly benefit from an allocation to the onshore Chinese government bond market in their portfolios.
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