RMB bond funds struggle despite index inclusion

The phased inclusion of 363 Chinese securities over 20 months from 1 April into the widely-tracked $54trn Bloomberg Barclays Global Aggregate Index (BBGA) could ultimately bring $2trn of foreign fund flows into China’s onshore debt market, according to Moody’s Investors Service, in a report published in late March.

HSBC GAM pointed out that there are about $2.5trn of assets that track the BBGA, and by the end of the 20-month phasing-in period, onshore Chinese bonds will comprise 6.1% of the index.

In addition, active investors would need to assess whether to buy CGBs, incorporating the sector into their portfolio allocation decisions. Strategists highlighted the diversification benefits of the market, as well as the high yields — above 3% on 10-year bonds — and the low, medium-term volatility compared with other government bond markets.

However, the hype has failed to boost the performance of dedicated RMB China bond funds. Since 1 April, the average return of the 40 funds authorised for sale to Hong Kong and Singapore retail investors is -2.27%, compared with 3.07% by the BBGA index, according to FE Analytics.

Even the best performing RMB funds over the long-term have struggled during the past three months, as investors turned risk-averse following a worsening of US-China trade tensions and an inversion of the US Treasury bond yield curve raised concerns that an economic slowdown might turn into a recession.

Nevertheless, the leading funds have posted strong three-year returns, well in excess of the BBGA’s return of 3.64%. Funds managed by Income Partners (17.97%) , BEA Union Investment (17.15%) and BOCHK (16.77%) stand out with returns in the high teens.

But their success is due to heavy allocations to Chinese high yield US dollar-denominated bonds, rather than onshore bonds issued by the government or any other entity, according to their factsheets.

In contrast, the worst performers have large allocations to domestic renminbi-denominated bonds. For instance, on 31 May 80% of the GF China RMB Fixed Income Fund’s holdings were in bonds issued by the state-run China Development Bank, according to FE. The fund has returned -18.37% over the last three years.

Positive signs

However, there is still confidence in China’s government bond sector.

“From a yield perspective, China fixed income markets are some of the best in the world, and particularly Chinese government bonds which are safe from a credit perspective, have low correlation to other markets, and have the potential to offer capital appreciation if, as expected, the global economy enters a slowdown,” said Hayden Briscoe, head of Asia-Pacific fixed income at UBS AM, in an email reply to FSA.

Moreover, foreign participation in China’s onshore bonds markets was given further encouragement by Liu Xiaoming, China’s ambassador to the UK, in a speech at an industry event in London this week.

He highlighted the recently launched Shanghai-London Stock Connect and said the two countries want to launch the equivalent for their bond markets.

In fact, trading on the existing Bond Connect between Hong Kong and Shanghai, set up in July 2017 to make it easier for overseas investors to access the country’s onshore bond market, has already seen a substantial pick-up in activity.

Tradeweb Markets, which was the first trading link to Bond Connect , said in a statement yesterday that volumes through Bond Connect reached a record last month.

Average daily volume in Chinese bonds reached a record $1.1bn on Tradeweb, which represents 406% increase since July 2017, according to the statement.

Comparative returns and volatility of RMB bond funds

Source: FE Analytics. Data in US dollars: 9 July 2016 – 6 July 2019

Top and bottom performing RMB fixed interest funds