Historically, investors outside of China have struggled to access the country's full range of unique investment opportunities. But this story is changing as policymakers seek to liberalize Chinese stock and bond markets to allow greater access to onshore Chinese investments.
At $17.5t trillion in assets, China is the second largest bond market in the world and offers unique and distinct portfolio attributes. [Source: Source: WIND, as of December 2020.] Although various reforms such as the introduction of Bond Connect, have simplified access to the onshore Chinese bond markets, supporting over $500bn of foreign capital into the market - more than half of which has been gathered since 2019, [Source: Bloomberg and JP Morgan index inclusion have completed as of end 2020, with FTSE WGBI inclusion planned to commence in October 2021. Estimated inflows from three indices respectively are US$150bn, US$30bn and US$150bn respectively.] foreign investment stands at only 3%. As Chinese markets continue to open, market participants expect increasing levels of foreign investment, benchmark inclusion, and tradability. Institutional portfolios need to consider the impact this evolution will have on their portfolio profile, returns and tracking implications.
Given the attractive portfolio attributes that the market offers, coupled with China's focus on the quality of its economic growth trajectory, Pension schemes should consider how China bond allocations can support their long-term funding and diversification needs as they head into the next decade.
A unique opportunity?
China bond total returns provide attractive diversification benefits given their low correlation to other developed market bonds. When bond markets around the world were rocked by the beginning of the Covid-19 pandemic, China bonds were relatively flat. The asset class also offers higher yields than developed market debt, a topic of significant importance given the global yield scarcity that has existed for many years. Today, half of all bonds that yield 2.5% or more - both government and credit - are in China.
FTSE World Government Bond Index (WGBI) inclusion confirms China's arrival on global bond stage
In March 2021, FTSE Russell announced that Chinese government bonds will be included in its flagship FTSE World Government Bond Index (WGBI) and its derived indexes. The inclusion is to occur over a period of 36 months commencing with an effective date of 29 October 2021 (thus spanning from Nov. 2021 to Oct. 2024). The projected weight of China in the WGBI index is roughly 5.71% based on August 2021 index profile. This confirmation is based on affirmation with members of the FTSE Russell advisory committees and other index users that ongoing reforms to the Chinese government bond market warrant inclusion in the WGBI.
Since its September 2020 Fixed Income Country Classification Results Announcement, FTSE Russell has engaged closely with Chinese authorities and market stakeholders to monitor previously implemented market enhancements and recent reforms to facilitate easier participation by international investors. These include simplification of the account opening process, the option to transact foreign exchange with third parties and the freedom to lengthen the settlement cycle beyond T+3.
Zhanying Li, Senior director, head of Data & Analytics product sales, APAC, FTSE Russell: "Foreign ownership of Chinese governments continues its upward trend, it is over 11% by end of July 2021. In fact, the net inflow into Chinese government bond market by foreign investors for the first seven month of 2021 is a stunning 81% of total net issuance during the same period."
For more information about the inclusion of China Bonds into FTSE WGBI, please download our research here
ETFs play a crucial role in providing China bond access
Many bond portfolios remain heavily underweight to China, with average allocations at just 0.05%. [Source: Portfolio average allocation figures based on BPAS EMEA client portfolios gathered between 31 Dec 2019 and 31 Dec 2020.] This active underweight could have material and unintended implications for yield, returns and tracking, and Pension schemes are increasingly having to focus on what this means for their portfolio.
While Chinese markets are opening to foreign investors, the operational complexities of setting up direct trading and access has proven to be a time consuming and resource intensive process. Pension schemes in the UK are discovering that the time and resource commitment to achieve local onshore trade and settlement is high. European domiciled and European listed ETFs that trade in local time zones provide investors with a significantly more simplified access route to gain the desired exposure. Asset managers with global scale and local expertise who can deliver product and trading efficiency are playing a key role for investment industry.
iShares' China Bond ETF suite has experienced an accelerated rate of adoption, with aggregate assets surpassing $13bn since the first funds were launched in 2019. Secondary market trading and liquidity has also improved significantly. The ability to trade in size, at low cost, and in real-time, has driven the growth and adoption of China bond ETFs for efficient market access. [Source: BlackRock, as of 31/08/21]
In summary - a market that cannot be ignored.
Though the numbers remain small compared to the size of the country's market, China bonds are a growing component of global bond indices - investors won't be able to ignore them for much longer. Diversification and yield benefits are particularly attractive, and while geo-political risks exist, this growing and increasingly high-quality market is an allocation that we believe institutional investors will be focusing more on in the future.
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy.
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