China's Long-Overlooked Bonds Look Pretty Attractive Right Now

China's Long-Overlooked Bonds Look Pretty Attractive Right Now

over 3 years ago2 mins

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Long-overlooked Chinese bonds are seeing a surge in interest from overseas investors – but it might be a good idea to go East before the country’s currency gets any stronger 🤔

What does this mean?

Investors’ search for security** *in a post-pandemic world means many government bonds (and a fair few corporate ones too) currently offer negative* returns – especially when taking inflation into account. Not so in China. While recently hitting four-year lows, 10-year Chinese government bond yields of 3.2% far eclipse US equivalents’ 0.7%.

Return-starved foreigners are cottoning on, even as domestic investors focus on stocks. A quarter of the world’s bonds are issued in emerging markets, with China responsible for more than half that. Four years ago, foreign investors owned just 1% of Chinese yuan-denominated bonds. Yet while that figure has now climbed to around 3% (9% for Chinese government debt), or $400 billion, the world’s second-largest bond market remains significantly under-represented abroad.

Major emerging economies typically have much higher rates of foreign bond ownership
Major emerging economies typically have much higher rates of foreign bond ownership

The pace of foreign investment tripled in July compared to last year, with bonds issued by the country’s three “policy banks” attracting even more money than government debt. And that may soon accelerate further: as of last week, Chinese debt is set for inclusion in the influential FTSE World Government Bond Index from March 2021. Passive investment from exchange-traded funds (ETFs) alone may amount to an additional $140 billion, with China’s bonds likely to account for 6% of the index – more than the UK’s 😯

Why should I care?

Many big investment managers are currently expanding their presence in (and exposure to) China, attracted by government reforms: investment bank Morgan Stanley sees $3 trillion of foreign money flooding into China over the next ten years. The country’s growing independence from US central bank policies means its bond market is less likely to follow the rest of the world’s; easy-to-access investments like the hot new ICBC CSOP FTSE Chinese Government Bond Index ETF could therefore offer welcome diversification as well as returns.

Of course, China’s self-determination also brings risks. Besides geopolitical tensions, the country’s government exercises close control over money flows – and the value of its currency.

An apparent shift in China’s economic growth strategy – away from export expansion and towards cheaper imports and stronger domestic consumption – means China may now be letting its currency grow stronger. After hitting its lowest level since 2008 last year, the yuan last quarter made its biggest gains on the dollar since at least 1981 as the latter’s international value fell and China’s economic recovery outpaced other countries’.

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But the yuan is still close to its weakest level in six years versus the euro – the currency of a major trade partner. Numerous investment banks therefore expect its value to further strengthen in the coming years, meaning foreign buyers of Chinese yuan-denominated bonds may get less bang for their buck. With increased international interest also potentially pushing down yields, now could be a good time to Enter The Dragon… 🐲

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