Chinese government bonds: increasing focus among investors
In recent years, China has been driving access to its local financial markets and their integration into global financial markets through a series of reforms. International investors now also have the opportunity to invest in Chinese government bonds on an indexed basis.
Over the past 20 years, China's economy has shown growth that can be described as extraordinary, historically speaking. Especially after joining the World Trade Organization (WHO) in December 2001, growth accelerated disproportionately. With a contribution to global GDP of 18% in 2021, China is the world's second largest economy after the USA (24%).
Where do the Chinese capital markets stand in a global comparison?
The two mainland exchanges in China, the Shanghai Stock Exchange and the Shenzhen Stock Exchange, are among the largest exchanges in the world in terms of market capitalisation. The Chinese bond market is now the second largest in the world, with a volume equivalent to more than USD 20 trillion after the US bond market (USD 48 trillion). The government bond market accounts for around 40% of the volume. With double-digit growth in recent years, it is also one of the world's fastest-growing bond markets. Despite the increase by international comparison, the absolute level of Chinese government debt has so far been low – it amounted to around 73% of GDP in 2021.
Access to Chinese local currency government bonds
In November 2014, the Stock Connect programme was launched, enabling both investors in mainland China and international investors to trade shares on the Shanghai Stock Exchange and Hong Kong Limited. In a further step, trading in Chinese bonds was liberalised in 2017 via the launch of the Bond Connect programme. Foreign investors had the opportunity to purchase bonds issued in China in the local currency of Chinese yuan (CNY) from the Hong Kong trading venue from this point on. As both the primary and secondary markets were covered by the new access platform, this led to a dramatic increase in liquidity.
As a result of this new presence, Chinese government bonds were gradually included in the benchmark indices of global index providers. For example, the Bloomberg Global Aggregate Bond Index started in 2019 (China weighting: 8.7%[5]) and the J.P. Morgan GBI EM Diversified Index in 2020 (China weighting: 10%5) with the gradual inclusion of Chinese government bonds. From November 2021, Chinese bonds are now being gradually included in the FTSE World Government Bond Index (China weighting: 1%5) over a period of 36 months.
The inclusion in the global benchmark indices means that Chinese government bonds have been and continue to be included in the portfolios of international investors. Nevertheless, many investors are still underinvested in relation to the size of the market. This is why the proportion of foreign investors will continue to increase. What's more, Chinese government bonds offer a globally diversified bond portfolio with attractive properties, both historically and currently.
Due to the increase in global interest rates in recent months, the yield advantage of Chinese government bonds over comparable international bonds has decreased slightly. However, Chinese government bonds are of a high quality with an A+ rating, an average duration of 5.58 years and lower volatility than comparable government bonds. This is due to the fact that Chinese monetary policy has historically been largely autonomous. Chinese government bonds are characterised by a historically low correlation with other asset classes. This offers a global bond investor opportunities for risk minimisation.
Risk of government intervention
The increasing regulatory trends in private sectors and the targeted cooling of the real estate market show the Chinese government's continued strong intervention in the domestic financial market. In addition to these political risks, there is a risk of sharply increasing public debt; currency and ESG risks also cannot be ruled out. On the other hand, China has a great interest in drawing foreign capital into the country. Not only does China need to attract more capital from international investors in the future due to its structurally declining current account surplus, but it also needs to develop a sustainable pension system as the population is ageing rapidly.
Indexed investment solutions
Besides products on the above indices, investors can also invest specifically in the Chinese market for (government) bonds via ETFs and index funds. The Swisscanto (CH) Index Bond Fund China Govt. is a cost-effective option for Swiss investors.
Legal notice: The publications were prepared by the Buy-Side Research of the Asset Management of Zürcher Kantonalbank. The information contained in this document has not been prepared in accordance with any legislation promoting the independence of financial research, nor is it subject to any prohibition on trading following the dissemination of financial research.
