Evolution of China’s onshore bond markets
China’s onshore renminbi bond market is the second largest in the world after the U.S. Though foreign ownership in the country’s bond market has been growing, it remains relatively small, compared to that of Emerging Market (EM) and G10. Currently, foreign investors enjoy preferential tax advantages which were announced in late 2018 (and are applicable for the next three years). While multiple programs grant access to the Chinese bond markets, there are some marked differences.
Asset allocation considerations when investing in Chinese onshore bonds
There is a compelling case for foreign investors to make a dedicated allocation to Chinese onshore bonds, as they offer low correlation dynamics, diversification benefits, and compelling risk-adjusted returns. The low correlation dynamic, which is partly driven by the asynchronous economic cycles between China and other major economies will likely persist, even as foreign bond ownership rises.
Given China’s significance, we believe a higher allocation to the country’s bond markets than what is currently assigned in the key global bond indices, is justified. Active managers are also in a better position to harness the investment opportunities within the Chinese bond markets compared to passive strategies which have mostly overlooked the country’s non-rate sectors. Currency hedging costs, which can have a material impact, should be given sufficient consideration. Long-term investors may prefer to leave the renminbi exposure unhedged to capitalise on the structural changes happening in China’s capital markets.
Cyclical and structural changes in China’s onshore bond markets
The pandemic will accelerate de-globalisation trends, China’s digital transformation and its capital market reforms which are playing out even in the domestic credit markets. Early investors in China’s onshore bond markets are also likely to benefit from the secular decline in real interest rates, as the nation’s population ages. China’s growth, interest rate, and current account edge will lend support to a stable renminbi and further anchor Chinese bonds as an alternative safe-haven asset class as the country’s exceptionalism rises.