Matthews Asia Perspectives
Perspective: China's Bond Market Matures with Inclusion in Global Index
March 29, 2018
For most of us, our 21st birthday was a milestone. It meant we were finally adults—in our own eyes and by the laws of society. Bloomberg’s recent announcement that it will include China into the Bloomberg Barclays Global Aggregate Bond Index (Global Agg) is like China’s bond market turning 21. The most widely used fixed income index provider is recognizing that China has a developed bond market. It affirms it has reached a maturation level equivalent to other developed markets and is no longer just another developing or emerging market.
Bloomberg said Chinese renminbi-denominated government and policy bank bonds will be included in the Global Agg starting in April 2019. The inclusion is subject to some operational enhancements, the ability to allocate block trades across portfolios and clarification of tax treatment of the bonds. The weight will scale up slowly over a 20-month period, with China’s weight reaching 5.49% of the overall index. When fully included, China will represent the fourth-largest currency weight, after that of the U.S. dollar, the euro and the Japanese yen. This scaling-in period is longer than typical and is meant to allow investors time to put in place any administrative and operational requirements.
Assuming that the assets managed to the Bloomberg Barclays Global Aggregate Bond Index stay flat, we estimate that approximately US$100 billion would be flowing into China’s bond market just from passive flows. This will be a game changer for a market that has seen little foreign participation despite having grown to become the third-largest bond market in the world. Part of this has been due to historically high barriers to entry, many of which have been dismantled over the past decade.
After decades of reform, China bonds will finally meet all the eligibility criteria for the Global Agg inclusion: securities must be rated investment-grade and its currency must be freely tradable, convertible, hedgeable and free of capital controls.
Benefits for Investors
China’s investment-grade bonds offer attractive investment characteristics that can help diversify and enhance global portfolios. The chart below, for example, illustrates the current yield, currency return, and volatility of a five-year government bond of the top constituents of the Global Agg:
Chinese bonds present an opportunity to reap the returns of the yield and the currency appreciation. As such, we believe China bonds are attractive not only from a yield perspective, but also from a currency appreciation standpoint. Moreover, given their low historical volatility, we have found that they provide attractive risk-adjusted returns as well.
The Matthews Asia Approach
China’s bond market offers attractive return potential, as well as risks. These risks can include currency, credit and interest rate risks. Notably, these risks are also the very same drivers of return for Asia fixed income. At Matthews Asia, we take an active approach to building Asia fixed income portfolios that closely examines and considers both financial risks and opportunities for generating returns in the portfolio selection process. In the current environment of rising interest rates, for example, we are keeping duration (a measure of interest rate risk) lower than the benchmarks for our strategies. We also closely consider the creditworthiness of individual issuers and currency trends of individual countries when buying and selling bonds for our portfolios.
Our firm was founded with a strong belief in the long-term growth potential of Asia’s regional economies and capital markets. The inclusion of China into the Global Agg marks an important coming of age for China’s bond markets. It provides positive re-enforcement for the market reforms and steps toward liberalization that the Chinese government has undertaken. It is validation that Chinese bonds are investable and investment-worthy. We believe Asian fixed income—including Chinese bonds—should be an integral part of a globally diversified bond portfolio.
Teresa Kong, CFA
Investments involve risk. Past performance is no guarantee of future results. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation.
Fixed income investments are subject to credit, currency, and interest rate risks. Credit risk is the change in the value of debt securities reflecting the ability and willingness of issuers to make principal and interest payments. Currency risk is a decline in value of a foreign currency relative to the U.S. dollar which reduces the value of the foreign currency and investments denominated in that currency. Interest rate risk is the possibility that yield will decline due to falling interest rates and the potential for bond prices to fall as interest rates rise.
The views and information discussed in this report are as of the date of publication, are subject to change and may not reflect current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. Investment involves risk. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. Past performance is no guarantee of future results. The information contained herein has been derived from sources believed to be reliable and accurate at the time of compilation, but no representation or warranty (express or implied) is made as to the accuracy or completeness of any of this information. Matthews Asia and its affiliates do not accept any liability for losses either direct or consequential caused by the use of this information.