- Amidst the carnage in global bond markets, Chinese government bonds stood out as a safe haven. While the Bloomberg Barclays Global Aggregate Index is down by almost -3.8% for the year, Chinese government bonds have delivered a total return of 1.1%.
- Not only do Chinese government bonds offer much higher yields compared to similar-tenured government bonds issued by developed economies, the lack of volatility in the Chinese government bond market has also added further allure to the investment case.
- Given that Chinese government bonds have traditionally exhibited low correlation with other fixed income markets, they can also provide diversification benefits to any global fixed income portfolio.
- At a time when major central banks around the world remain intent on keeping their monetary policies loose despite the risk of inflation, PBOC has taken a more balanced approach in its monetary policy. Fears of a sudden monetary tightening are more prevalent in the Western developed economies.
- China has made considerable efforts over the past decade to improve the accessibility of the onshore bond market to foreign investors. The inclusion of Chinese government bonds in major fixed income indices is also another factor that will drive increased foreign participation in the future.
From the US to Germany and Australia, government bond yields across the world have been surging, as fears that a faster-than-expected economic recovery would lead to higher inflation and hasten policy tightening unsettled bond markets.
Amidst the carnage in global bond markets, one fixed income market stood out as a haven: Chinese government bonds.
While the Bloomberg Barclays Global Aggregate Index, which tracks the performance investment-grade debt in both advanced and emerging markets, is down by almost -3.8% for the year (as of 24 March 2021), Chinese government bonds have performed well year-to-date, with the FTSE China Government Bond Index delivering a total return of 1.1% (in USD unhedged terms as of 24 March 2021).
For investors who are looking out for options to further diversify their global fixed income portfolios, they should look no further than Chinese government bonds.
Higher yields compared to developed market government bonds
Chinese government bonds offer much higher yields compared to similar-tenured government bonds issued by developed economies. While the extra yield pick-up offered by Chinese government bonds over US Treasuries has narrowed this year to about 158 basis points, compared to about 226 basis points at the start of the year, they continue to provide investors with significantly higher real yields (Table 1).
Table 1: Chinese government bonds provide significantly higher real yields
|
Market |
Credit Rating |
10Y Nominal Yield (%) |
*Inflation (%) |
Real Yield (%) |
|
China |
A+ |
3.18 |
1.6 |
1.58 |
|
Singapore |
AAA |
1.58 |
1.0 |
0.58 |
|
Japan |
A+ |
0.07 |
0.1 |
-0.03 |
|
Australia |
AAA |
1.68 |
1.8 |
-0.12 |
|
Italy |
BBB |
0.59 |
0.9 |
-0.31 |
|
Switzerland |
AAA |
-0.38 |
0.3 |
-0.68 |
|
US |
AA+ |
1.60 |
2.4 |
-0.80 |
|
UK |
AA |
0.72 |
1.6 |
-0.88 |
|
France |
AA |
-0.13 |
1.2 |
-1.33 |
|
Germany |
AAA |
-0.38 |
2.0 |
-2.38 |
|
Source: Bloomberg Finance L.P., iFAST Compilations Data as of 24 March 2021, based on Standard & Poor’s ratings *Based on consensus forecast for inflation in 2021 |
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Other large Asian economies like Indonesia and India do offer higher yields, but they also come with a higher level of credit risk as well. 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. Compared to Indonesia (BBB) and India (BBB-), China’s government bonds are four-to-five levels more creditworthy.
However, it is not just the absolute level of China’s government bond yields that appeal to investors, the lack of volatility in the Chinese government bond market has also added further allure to the investment case. The yield on China’s 10-year bond has been in a tight 10-basis point range over the past month, even amidst a sharp surge in the 10-year US Treasury yield by 53 basis points (Chart 1).
Chart 1: China’s 10-year bond yield remains stable even as Treasury yield surges
In an environment where fixed income investors are starved of yield on sovereign bonds, and at a time of increasing volatility in bond markets, Chinese government bonds are certainly a standout option.
Low correlation with other fixed income markets
Given that Chinese government bonds have traditionally exhibited low correlation with other fixed income markets, they can also provide diversification benefits to any global fixed income portfolio. As such, it is unsurprising that bond investors are increasingly turning to China as an effective hedge against a broad downturn in equities.
Since 2009, the correlation between Chinese government bonds and global bonds has been low at 0.25. In a further sign of just how insulated the market is, the correlation between Chinese government bonds and global bonds was near-zero in the recent rout that gripped bond markets globally. A reading of 1 indicates a perfect, positive correlation between the two, while zero indicates no correlation at all.
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. The People's Bank of China’s (PBOC) more measured approach in its monetary policy, compared to most developed markets, is an example of this.
At a time when major central banks around the world remain intent on keeping their monetary policies loose despite the risk of inflation, PBOC has taken a more balanced approach in its monetary policy, focusing on cooling credit growth and reining in financial risks without derailing the ongoing economic recovery or causing broader market instability.
Also, the massive stimulus measures implemented in the developed world are expected to result in a flood of new debt issuance, a factor that will further accelerate the surge in bond yields. This is in stark contrast to China, which has eschewed massive stimulus for greater fiscal discipline.
As such, fears of a sudden monetary tightening are more prevalent in the Western developed economies, especially amongst bond investors who may have inflation concerns. For such investors, Chinese government bonds, which are supported by a more stable and moderate monetary policy, are certainly a viable option as a fixed income diversifier.
Increased foreign ownership of Chinese onshore bonds to drive inflows
While foreign investors account for only a small slice of the onshore Chinese bond market, China has made considerable efforts over the past decade to improve the accessibility of the onshore bond market to foreign investors. As of February 2021, foreign investors held a record of more than CNY 3.6 trillion of onshore China bonds representing a nearly 60% increase from the amount held in the same period last year (Chart 2).
Chart 2: Foreign holdings of China onshore bonds at a record high
The establishment of the Qualified Foreign Institutional Investor Scheme (QFII) in 2002, the RMB Qualified Foreign Institutional Investor Scheme (RQFII) in 2011, and more recently, the China Interbank Bond Market Direct (CIBM Direct) in 2016 and Bond Connect in 2017 have all allowed foreign investors to trade Chinese onshore bonds more easily and freely without being subjected to restrictions, such as quotas or lock-up periods.
The inclusion of Chinese government bonds in major fixed income indices is also another factor that will drive increased foreign participation in the future. Already, Chinese government bonds and policy bank bonds are included in the Bloomberg Barclays Global Aggregate Bond Index and the JPMorgan Global Bond Emerging Market Index. FTSE Russell has also be adding Chinese Government Bonds to its FTSE World Government Bond Index, with inclusion scheduled to start in October 2021 (subjected to final affirmation later this month).
The index inclusion could potentially lead to inflows of about USD 200-300 billion into Chinese government bonds. Given its relative yield attractiveness and improved accessibility, we expect foreign investors to gradually warm up to this market in the future, a development that will certainly accelerate inflows into one of the most under-owned sovereign bond markets in the world, supporting bond prices and the onshore RMB in the longer-term.
Fixed income ETFs to consider for Chinese government bond exposure
For investors seeking exposure to Chinese government bonds, the NikkoAM-ICBCSG China Bond ETF (SGX:ZHY, SGX:ZHD, SGX:ZHS) and the ICBC CSOP FTSE Chinese Government Bond Index ETF (SGX:CYB, SGX:CYC), both of which are listed on SGX, are viable additions to their fixed income portfolios, offering diversification opportunities and relatively higher yields compared to developed market sovereign bonds.
Compared to their Hong Kong-listed peers, the two SGX-listed ETFs are much more cost-effective, with expense ratios of 0.25-0.30% that are less than half of that charged by the Hong Kong-listed ETFs (Table 2). In addition to having lower expense ratios, the NikkoAM-ICBCSG China Bond ETF and the ICBC CSOP FTSE Chinese Government Bond Index ETF also stack up well against their peers in other measures, such as liquidity and assets under management (AUM).
Dividend distributions for both ETFs are expected to be made on a semi-annual basis. Additionally, investors who intend to invest in the NikkoAM-ICBCSG China Bond ETF should note that only the SGD class units (SGX:ZHS) pay regular dividends.
Table 2: Comparison of various Chinese government bond ETFs
|
Name of ETF |
Expense Ratio (%) |
Average Daily Volume |
AUM (CNY bil) |
Yield (%) |
|
NikkoAM-ICBCSG China Bond ETF |
0.30 |
182,500 |
1.32 |
3.16 |
|
ICBC CSOP FTSE Chinese Govt Bond Index ETF |
0.25 |
93,800 |
8.03 |
3.03 |
|
CSOP Bloomberg Barclays China Treasury + Policy Bank Bond Index ETF |
1.05 |
5,100 |
0.32 |
3.21 |
|
ChinaAMC Bloomberg Barclays China Treasury + Policy Bank Bond Index ETF |
0.85 |
1,400 |
0.04 |
3.21 |
|
Source: Bloomberg Finance L.P., iFAST Compilations Data as of 24 March 2021 |
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Investors can benefit from Chinese government bond exposure
By many traditional measures, such as GDP per capita, China remains an emerging market in the eyes of most market participants and index providers. This classification, however, belies the fact that China’s onshore bond market is the second largest in the world, just behind the US. Unlike other emerging markets, its economy is now a primary driver, rather than a beneficiary, of global growth.
China’s status as an emerging market has also reinforced a commonly-held, but misplaced, belief that Chinese bonds are a risky part of the fixed income universe, resulting in them being grossly under-represented in most global fixed income portfolios.
As we’ve highlighted in this article (and in previous articles as well), 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. As such, Chinese bonds can be considered a safe haven asset.
Their decent yield and low correlations with global bonds also mean that fixed income investors can certainly benefit from an allocation to onshore Chinese government bonds in their portfolios.
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