Risks vs rewards of investing in onshore Chinese bonds

May 6, 2021

The size of China’s bond market

China’s onshore bond market has doubled in the past five years. The fixed income market expanded by 18% to RMB114tn (USD17tn) in 2020; local governments (which issued 22% of total outstanding bonds), the central government (18%), and policy banks (16%) were the largest issuers.

Flows to China’s bond market

China’s bonds have recorded average net monthly inflow of a little over USD9bn over the past two years. FTSE Russell announced that it would include China government bonds in the World Government Bond Index over a period of three years. Their weightage would be 5.25%, translating into inflow of USD150-180bn.

Accessibility reforms, index inclusion and onshore opportunities attract global capital; however, foreign investors own only 2.5% of the market. Commercial banks are the main investors in local-government bonds, holding c.85% of total local-government bonds outstanding as of March 2021.

The case for investing in China government bonds

For global asset managers, China bonds are an attractive option, as they enhance returns (spread of ~300bps over aggregate G3 yields) while de-risking a portfolio (correlation of >0.2% with major developed-market global bonds).

Investor concerns on China’s onshore bonds

Given the value added to global portfolios, asset managers are likely to want a share of China’s bond market (the world’s second largest). However, there are risks:

  1. Recent defaults by state-backed issuers (which account for c.60% of the outstanding bonds) have caught investors off guard

  2. The low credibility of domestic rating agencies (<90% of the bonds are rated AA and above), as the recent defaults were by issuers rated AA and above

  3. Lower transparency, weak governance standards and international investors’ lack of expertise in the local language

About the Authors

Associate Directors, Fixed Income & Credit Research

Harshwardhan Khandelwal has over 10 years of work experience in investment research, with a focus on financial institutions, sovereigns and supranational entities. He currently supports a large European buy-side client. The process involves performing fundamental and technical analyses of issuers and discussions with the client’s rating committee. He is also actively involved in training, quality control of deliverables, and other client discussions. He holds an MBA and a bachelor’s degree in Mechanical Engineering.

Associate Directors, Fixed Income & Credit Research

Jeetendra Prakash has over 10 years of work experience in investment research, with a focus on oil and gas and real estate. He currently supports a large European asset manager. The process involves research on potential acquisitions of real estate assets and also supports a distressed debt fund. In addition, he is also actively involved in training and quality control of deliverables. He holds an MBA and a bachelor’s degree in Commerce.