Bond markets experienced significant volatility over the past year. With government bond yields rising across the world, investors are increasingly jittery about how a post-pandemic recovery in growth and inflation would impact fixed income prospects.
Attaining stable income without significant risk to principal is becoming difficult for investors as a result of rising yields. Moving ahead, interest rate risk will likely be the main risk factor for investors, as the global economic reopening accelerates. Yield-seeking investors may therefore find it difficult to achieve their income targets if they do not take on higher credit risk.
Are there any good options out there?
The Chinese government bond market is one of the last fixed income bastions that fulfills our requirement of decent yields, muted credit risk, and relatively low duration risk. To date, Chinese government bonds stand as one of the best fixed income performers, with the FTSE China Government Bond Index delivering a total return of 4.52% (in USD unhedged terms as of 31 May 2021). In contrast, the Bloomberg Barclays Global Aggregate Index, a proxy for global bonds, is down 2.35 % for the year (as of 31 May 2021).
What are the reasons to include China RMB bonds in your fixed income portfolio?
In our view, there are three reasons why we think investors should consider including RMB bonds into their fixed income portfolio: i) Chinese government bonds provide significantly higher real yields, ii) low correlation to other fixed income markets and iii) structural demand resulting from future inclusion into global indices.
Higher yields without higher credit risks
Despite how the extra yield pick-up offered by Chinese government bonds over US 10Y treasuries have narrowed significantly, from 230 basis points to about 150 basis points at the start of the year, Chinese government bonds still provide higher real yields compared to similar tenured government bonds issues by developed economies.
Table 1: Chinese government bonds provide higher real yields compared to peers
Chart 1: Chinese government bonds provide a sweet spot between yields and credit risks
Lower inter-market correlations mean higher diversification for your portfolio
Chinese RMB bonds have demonstrated low correlations to other key asset classes around the world, making them an attractive option for improving diversification and risk-adjusted returns. To put things into perspective, let’s take a look at Chart 2 below. Over the last 5 years, Chinese bond yields have generally not been affected by the movement of US 10Y treasury yields, which may explain why Chinese RMB bonds have emerged from the past one year’s bond sell-off relatively unscathed, and continue to stay resilient despite persistent rate and inflation scares.
The reason for Chinese bonds’ low correlation with global bonds, we believe, is because of low foreign ownership and its performance tends to be more domestically driven. As China is still fast-growing and remains the main engine for global GDP growth, changes in domestic growth expectations arguably impact its bond yields more than non-domestic factors.
Chart 2: Chinese bond yields have ranged between 2.5% - 4% while US bond yields have ranged 0.5% - 3%
Global investors want more exposure to Chinese securities
As China’s economy grows larger, more investors are looking to gain exposure to its burgeoning financial market. While there have been steps taken to increase accessibility to foreign investors, Chinese regulators are likely to adopt a measured approach, and therefore investors should view this as a long-term structural theme.
Over the past two decades, some of the improvements made by regulators to increase accessibility to Chinese bond markets include 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). These schemes have allowed foreign investors to gain exposure to Chinese onshore bonds more easily and freely without being subjected to restrictions.
The inclusion of Chinese government bonds in major fixed income indices may also drive further foreign participation in the future. According to BNP Paribas, between USD200-300 billion would flow into the asset class as a result of the inclusion. This likely leads to higher demand and price appreciation for certain segments of the Chinese bond market.
What is the Fidelity Funds – China RMB Bond Fund all about?
The fund is managed by Morgan Lau who has 19 years of investment experience, and he also manages the Fidelity Asian Bond Fund. Fidelity China RMB Bond Fund typically invests in investment-grade RMB-denominated bonds, money-market securities, with the flexibility to take advantage of cross-market opportunities in the offshore market, whilst maintaining overall RMB exposure.
What’s interesting is that the fund captures the best of both worlds – the onshore and offshore China market and seeks to deliver a total return strategy with a focus on investment grade and lower volatility.
By investing in this fund, investors can expect to gain exposure to China’s ever-growing fixed income space via three different markets, namely i) the onshore CNY market, ii) offshore USD market and iii) offshore CNH market. These markets all have different characteristics, which will allow the fund manager breadth to construct a portfolio with suitable risk-return characteristics.
Looking under the hood, we realize that the fund’s core holdings mainly include onshore bonds, such as Chinese government bonds, policy banks, and some China state-owned enterprises (SOEs). These tend to be highly liquid securities. The offshore USD bond market on the other hand allows investors to obtain exposure to quasi-sovereigns, banks, and a diverse range of corporate issuers.
Lastly, the offshore CNH bond market is the smallest but comes with uniquely stable and high-quality issuers. Such diversification across various bond markets will provide the fund with a stronger ability to weather difficult bond market conditions.
How has the fund done compared to its peers?
On a year-to-date basis, the fund has underperformed the FTSE China Government bond index, albeit while exhibiting significantly lower volatility. However, it has outperformed global bond funds on our platform by a significant margin, likely due to the fact that the holdings of the fund are denominated in RMB, enabling the fund to leverage on the weakening USD/CNY and CNH pair, thereby enhancing the overall returns of the fund.
Besides, the fund also has a shorter duration as compared to other global bond funds on our platform. Being relatively short on duration allowed the fund to remain resilient amidst rising yields.
Chart 3: Fidelity fund – China RMB Bond Fund underperforms FTSE Chinese Government Bond Index
Chart 4: Fidelity fund – China RMB Bond Fund outperforms Global bond funds on our platform
Who should buy this fund?
In short, the Chinese bond market’s scale, diversification potential, and relatively attractive yields make it hard for one to ignore. This fund would likely appeal to many types of investors; risk-averse investors seeking a relatively safe and low rate of return, global investors seeking uncorrelated sources of returns, or investors worried about inflation eroding away their purchasing power. If you fit into any of the above investor types, allocating some of your monies into Chinese bonds right now would be highly suitable.
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