The Chinese bond market has taken a significant step towards integrating with the global financial system with the phased inclusion of Chinese government bonds and policy bank securities in the Bloomberg Barclays Global Aggregate Index starting this month.
The addition of these securities is being phased in over a 20-month period. When fully accounted for in the index, local currency Chinese bonds will be the fourth largest currency component following the US dollar, euro and Japanese yen.
Bloomberg estimates that, using data as of January 31, 2018, the index will include eventually 386 Chinese securities and represent 5.49% of a $53.73trn index. The process will run over the next 20 months in 5% increments.
The inclusion of any emerging market carries many long-established conditions from the index-provider. A local currency debt market must be classified as investment grade and its currency must be freely trade-able, convertible, hedge-able, and free of capital controls. Bloomberg says that ongoing enhancements from the People’s Bank of China have resulted in RMB-denominated securities meeting these absolute index rules.
In addition to the Global Aggregate Index, Chinese RMB-denominated bonds will also be included in Bloomberg’s Global Treasury and EM Local Currency Government Indices.
It is expected that the FTSE indices and eventually JP Morgan will follow suit.
The move is part of increasing integration of China with the global financial system. Last year, Chinese A-shares were included in the MSCI Emerging Markets Index while the “connect” programme allows investors to buy certain shares and bonds through Hong Kong’s stock market.
New investors will be conservative
Edmund Goh, Shanghai-based Asian fixed income investment manager at Aberdeen Standard Investments, said: “Adding China into Bloomberg and probably later FTSE will open the market up for international investors. Some would say they could invest without the index inclusion. But I think this inclusion changes two things. First how aggressively asset managers will pursue looking into this market and second demonstrating that the PBoC is willing to make market access easier. It makes a big difference.”
He suggests that it will bring significant chance to the onshore market long-term promising a much more diversified set of investors although he believes that for now most of the new investors coming into the Chinese market will be very conservative ones.
“They will aim for exposure to low or close to zero credit risk bonds – government and policy banks. In 12 to 18 months, you will see their presence. We are active in the market, and we can see the beginning of these flows now though it is still pretty small. I think increasingly you will see more active participation – it will increase the volume traded.”
“China needs a more diversified set of investors. The first step will be the interest rate market, the next step is to get foreign investors to be part of the credit markets though there is a language barrier and some idiosyncrasies with the local market. At the moment it won’t take off as the yield is not that attractive, but these things can change. These opportunities may come.”
He noted that default risk has risen recently though not in comparison to the US. Only recently have domestic investors started to embrace individual credit analysis and foreign investors can be an important influence. “Foreign asset managers are way, way ahead on the local fund houses.”
He also said he believes that global indexes are thinking putting in non-CGBs and security bank bonds in indices something that should also help with the development of the market.
Given Bloomberg’s decision to also offer products that exclude the Chinese bonds, Goh is sure that sure some international investors will look at a China excluded index. “The difference is that now it becomes an active decision – if you don’t want China you have to justify it. It becomes a non-mainstream product to exclude China, so with passive with an attractive yield and diversification benefit I would be surprised if most people go out of their way to exclude it out.”
He adds that this is a small step and the experiences of 2015 and 2016 with renminbi devaluation and huge stock market falls still play on Chinese policy makers’ minds given the loss of control for the government, the hurt felt by local investors and outflows of $1trn.
“They want the local banks to become more stable and the long-term ambition has not changed. You need to make people feel safe when they invest. They want to make sure investors can take money out too.”
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The China renminbi fixed income fund category versus various other categories
Source: FE Analytics. In US dollars.
Three-year annualised returns and volatility
| Sector | Return | Volatility |
| HKM Fixed Int Asia Pacific | 2.55 | 2.68 |
| HKM Fixed Int Emerging Markets | 2.66 | 5.34 |
| HKM Fixed Int Global | 1.5 | 3.02 |
| HKM Fixed Int RMB | 0.76 | 3.92 |
Source: FE Analytics. In US dollars
