Foreign firms peck at China’s $9trn bond market

Asset Class in Focus

Despite the inclusion of onshore bonds on some global indices, portfolio managers have taken minimal exposure to the onshore bond market, citing the payment settlement issue as a key obstacle.

Foreign firms peck at China's $9trn bond market

China’s liberalisation of its financial sector allows foreign investors to buy onshore bonds through the China Interbank Bond Market (CIMB) and through quota programmes, such as the Bond Connect.

But foreign investors account for only about 2% of China’s RMB 60trn ($9.10trn) bond market, according to data from the China Central Depository and Clearing Company.

Teresa Kong, who manages the Asia Strategic Income and Asia Credit Opportunities Strategies at Matthews Asia, allocated to Chinese onshore bonds shortly after the launch of the Bond Connect last summer.

“We think [Chinese onshore bonds] are providing attractive value from a credit, currency and interest rate perspective.”

She finds most value in what she calls “quasi-state bonds” or state-owned enterprises (SOEs) that are “very high quality from both a strategic perspective as well as a management perspective”.

Delivery vs payment

In total, Mathews Asia has between 10%-15% allocated to yuan-denominated bonds across different strategies. The percentage is low due to issues such as those surrounding payment settlement.

The obstacle is that delivery versus payment (DVP) for Bond Connect is not yet possible for foreign participants.

“In a typical settlements process, cash and bonds exchange hands instantaneously,” Kong said. “This means that at any point in the settlements process, you either have the cash or the bonds, not both or neither. Until DVP is possible, most custodians have not given a green light for public funds to transact.”

Andy Seaman, partner and CIO at Stratton Street, added that his firm hasn’t bought Chinese onshore bonds due to the DVP system. The delay between bonds being delivered and cash being received of even a few hours is not a true DVP system.

“So neither the Luxembourg nor Irish regulators allow Ucits funds to buy Chinese bonds via Bond Connect.”

Interest rate gap

Seaman is also watching the gap between US interest rates and China’s. “When interest rates in China are higher than in the US, this provides additional income when a hedge from US dollars to Chinese renminbi is executed,” he said.

“This additional income, when added to the underlying yield of the bonds which is currently 4.3% for our Renminbi Bond Fund, provide a yield of roughly 6.5%. There is nothing in the investment grade RMB bond space that comes close to that.”

Adrian Chee, co-manager of Credit Suisse (Lux) China RMB Credit Bond Fund, believes that valuations and a stable currency make the onshore bond market attractive.

“Market interest will continue to grow. We already launched a product more than six months ago and it has increasing demand.”

However, his firm only has 4% allocation to Chinese onshore bonds.

Desmond Soon, head of investment management for Asia ex-Japan and senior portfolio manager at Legg Mason Western Asset Management, agrees on the potential of the asset class, but admits he is taking it slowly.

“Since we have recently been granted China Interbank Bond Market (CIBM) access, we are gradually adding onshore bonds”. He explains that they have too experienced “technicalities executing and settling trades through the CIBM”.

The managers, however, said they expect the settlements issue to be sorted out and foreign buyers of onshore bonds to increase, given the prospect of a stable renminbi – thanks to a tight lid on capital outflows, China’s ongoing deleveraging of the financial sector and steady interest rates.

Also, RMB-denominated government and policy bank bonds were recently added to the widely-tracked Bloomberg Barclays Global Aggregate Index, a move that should encourage foreign buyers.

 

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