Given China’s onshore bond market being the second largest in the world behind the US, Chinese government bonds’ (CGB) inclusion within several of the largest global bond indices means the market is too big for investors to ignore, according to Dr. Xiaolin Chen, head of international at KraneShares.
Speaking at ETF Stream’s Big Call: Fixed Income ETFs event, Chen (pictured) highlighted numerous appealing factors for CGBs as there is still plenty of room for the asset class to grow.
China’s inclusion in the major global indices, both equity and fixed income, is still relatively new as Chinese stocks were only included in 2018 while bonds were included in April this year. There have been other events that have tried to enable foreign investors better access to the market and it appears to be working.
“The bond connect that was introduced in 2017 has remarkably increased the accessibility for international investors outside of China to access the onshore bond market,” Chen continued. “The issuance of CGBs has increased eight-fold in just two years with over a third of the 2019 supply of CGBs being bought by international investors.”
There is, however, still plenty of room for growth as Chen points out that only 2.2% of ownership in China’s onshore bond market is by foreign investors while this figure is over 30% for the US.
Additionally, despite being the second-largest bond market in the world, China only accounts for 5% of Bloomberg’s flagship index and 10% for JP Morgan. FTSE Russell, which announced last month it will also be including CGBs as of next year, will allocate 6%, according to Chen.
Chen said a catalyst for the increasing allocations in these indices would be introducing an independent rating agency. Enabling an agency to rate and assess the onshore bond market would increase the confidence of both index providers and investors.
Nonetheless, investors have shown their appetite for the market with Chinese government bond ETFs seeing significant inflows this year. The KraneShares Bloomberg Barclays China Bond Inclusion UCITS ETF (KBND) has captured $6.5m assets since its inception in May while the iShares China CNY Bond UCITS ETF (CNYB) continues to see its assets balloon having received $2.6bn net new assets year-to-date.
There are several other factors as to why CGBs can be an appropriate asset allocation for investors given the current climate for the rest of the global market, according to Chen.
“China is not pursuing ultra-low interest rates and CGBs actually offer high yields compared to most of the developed markets,” she said. “Most of the Chinese monetary easing has been focused on putting a large amount of liquidity into the money market rather than managing yield through yield curve control.”
Other appealing factors for CGBs include their higher yields and low correlation with the developed markets. The 10-year CGB offers around 140 and 150 basis point yield pick up over US treasuries. Compared to the rest of emerging Asia, China offers the highest sovereign credit ratings and again produces the highest yields.
“Chinese policymaking is taking a self-style to reflect its own domestic economic needs as opposed to other global central banks,” Chen added.
In addition to its low correlation, higher yields, index inclusions and room for growth, the onshore bond market also offers tax benefits to foreign investors.
Chen said: "Back to my days when I was a portfolio manager managing over $70bn assets, five years ago, John Krane, CEO of Kraneshares, asked how much fixed income allocation I had in China and it was literally nothing."
A lot has happened since then in terms of improving accessibility for foreign investors and as the ETF flows would suggest, investors are certainly looking at the Chinese bond market in search of yield.
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