The coronavirus crisis has changed many aspects of the world, but chronically low yields in Western bond markets are not one of them.
The debt of some of Europe’s largest economies is still trading at negative yields and the 10-year US Treasury – the linchpin of a global bond portfolio – is valued at a rate of just 0.68%.
However, in Asia’s largest bond market, that’s another story, even though there aren’t many international investors involved.
Chinese 10-year government debt yields rose steadily from April to trade above 3%. And although foreign investors traditionally own a tiny fraction of the market, signs of change are looming.
“More and more people are coming in, and this is just the beginning,” says Jan Dehn, Research Manager at Ashmore Group. “Asia is going to become very big,” he adds. “Asian markets will find their way into all of the major global bond indices.”
The international fixed income market is dominated by borrowers and politicians in Europe and the United States, where expansionary monetary measures have forced interest rates to record highs since the 2008 global financial crisis.
Dehn estimates that more than four-fifths of the roughly $ 30 billion outstanding emerging market debt is in local currency debt. Emerging market bonds made up a quarter of all fixed income securities in the world at the end of 2019, but, he said, were under-represented in bond investors’ portfolios and the indices they track. .
Nowhere is the under-representation more evident than in the Chinese domestic bond market, which alone accounts for more than half of all emerging market fixed income securities in terms of size, but a small proportion of global portfolios. . Within the emerging market funds themselves, China is also under-represented relative to its size due to the limitations of allocations for a single country.
In August, foreign investors held only 2.9% of Chinese debt in local currency, according to a report by French bank Natixis. It is nevertheless a record, which compares to just over 1% in 2016. Some expect this proportion to climb much higher.
Chaoping Zhu, Shanghai-based global market strategist at JPMorgan Asset Management, said long-term investors outside of China, such as pension funds and insurance companies, have “a strong interest in bonds. Chinese “. It points to “huge” foreign inflows of 148 billion RMB ($ 21.9 billion) into Chinese debt in July this year, compared to 53 billion RMB in the same period last year.
Access to China’s onshore bonds has always been difficult to navigate for these investors, although recent measures, such as the Bond Connect program, launched in 2017, have made it easier for investors to access fixed income products. in renminbi via Hong Kong.
For Edmund Goh, director of bond investments in Asia at Aberdeen Standard Investments, low levels of foreign investment in Chinese markets mean that when fixed markets move in one direction around the world, China is less likely to follow suit. .
“When you have more of your holdings held by foreigners, they’re more affected by global macro sentiment,” he says.
Mr. Goh adds that, relative to other markets, China was “isolated” and less directly affected by waves of accommodative global monetary policy, which he said lowered the yields of some other issuers in Asia. “You have a lot of markets that were producing higher returns,” he says. “For other markets such as [South] Korea, Thailand, yields have dropped considerably.
China is by no means the most profitable issuer in Asia.
The 10-year Indian government bond currently yields more than 6 percent, in a market where foreign investment is limited by the government.
A major constraint on investing in Asian local currency markets, including China, is currency risk. The renminbi does not have the international status of the dollar, the euro, or the pound sterling, and capital flows in and out of the country are tightly controlled by government policy.
This further amplifies the vulnerability of investors to changes in Chinese policymaking.
Tensions between the West and China escalated further this summer after Beijing imposed a draconian national security law over Hong-Kong. Yet signs of an increased appetite for Chinese debt have persisted as Beijing continues a wave of financial liberalization.
Many of America’s biggest fund managers are being spurred by Chinese government reforms to expand their presence in the country and take a bigger role in managing Chinese savings.
The presence of international managers can help familiarize more investors with onshore bonds. More deeply, Ashmore’s Dehn suggests that “China’s intention to continue to open up its market” could herald a change in the way money works globally.
“All the money has gone to the United States, it’s like a capital magnet,” he adds. “When this magnet loses its power and the money starts to come back, it begins to ease financial constraints in other parts of the world.”