Depending on how you measure these things, China is either the second-biggest economy in the world or already out in front. As such, it naturally has a big bond market. In fact, it is now the second-largest behind that of the U.S.
There are more than 5,000 issuers of onshore, renminbi-denominated bonds, and the outstanding value of that debt is more than $10 trillion. More than $6 trillion of that is corporate credit—virtually the same as the amount of debt represented by the Bloomberg Barclays U.S. Corporate Investment Grade Index.
And yet we still meet a lot of investors who don’t have China’s bond market on their radar screen, let alone as a dedicated allocation in their portfolios. Citi has estimated that foreign investors own less than 4% of the market, most of which is rates rather than credit, compared to an average of 40% for most other major developed and emerging bond markets.
How could this be?
The main reason is that China’s bond market has long been difficult to access. Even after recent liberalization, culminating in the launch of the Hong Kong Bond Connect channel, it remains operationally challenging to participate, especially in corporate credit.
Bloomberg is phasing 363 China onshore bonds into the Bloomberg Barclays Global Aggregate Index, and JPMorgan is making a similar inclusion in its GBI-EM Global Diversified Indices. But the sub-10% weights substantially underrepresent the relative size of the market.
Then there is the question of how committed China really is to market liberalization, particularly as relations with the U.S. and other countries have become more difficult. Beginning as a trade dispute two years ago, tensions have escalated markedly this year around everything from 5G security and the coronavirus to the future of Hong Kong, culminating in last week’s consulate closures. We think geopolitics has held back investment.
Access is not straightforward, then, and involves some risks. Is it worth it?
We would argue that it is.
China’s bond market is the source of some of the world’s most attractive risk-adjusted yield. China’s 60% sovereign debt-to-GDP ratio and its A+ credit rating from Standard & Poor’s stands up well against many of the world’s strongest sovereigns—but its 10-year debt trades with a yield of more than 3% and a near-record spread of 240 basis points over the U.S. 10-year Treasury.
In the corporate market, furthermore, it is normal for bonds to have put options that allow investors to demand early repayment—which would be valuable optionality in the event of rising interest rates. It is also the only place to get fixed income exposure to the real domestic economy of China, in all its diversity, as opposed to the government, financial, real estate and technology exposure that makes up 80% of the more easily accessible offshore U.S. dollar market.
Since 2011, the annualized return from this market has been around 5%, with virtually zero correlation to any other bond market—even other emerging markets.
And perhaps most surprising of all, it remained resilient even through the worst of the COVID-19 crisis earlier this year. By the end of April, the year-to-date return of the S&P China Bond Index was 3.7%. The number of first-time defaulters among corporate bond issuers has actually decreased substantially relative to 2019.
Indeed, the onshore market performed so well that, temporarily at least, and for those companies that issue bonds both onshore and offshore, the greater yield opportunity is, in our view, now in the U.S. dollar market, which sold off substantially as global liquidity withdrew.
Looking ahead, as well as proving resilient through the COVID-19 crisis, we think it’s likely that the China bond market could provide good exposure to the recovery. China was the first major economy hit by the pandemic and the first to return to growth: It expanded by 3.2% in the second quarter, when Europe and the U.S. were grinding to a halt, and economists project further growth of 5.5 – 6.0% in the second half of the year.
Our China fixed income team in Shanghai favors real estate and chemicals as areas with particularly strong recovery potential.
After plunging 69% year-over-year in February, home sales are now back in line with 2019. Government policy is generally supportive for homebuyers and mortgage rates are declining, while most real estate developers have managed to reduce their leverage through the crisis and enter the recovery with stable balance sheets.
In chemicals, the team is looking at the pure terepthalic acid (PTA) and fully drawn yarn (FDY) supply chain, a key source of material for clothing and the elastic straps on protective face masks. We already see a recovery in clothing sales in China, and anticipate ongoing growth in the Asia-Pacific apparel market over the coming years, while the huge demand for face masks seems to have alleviated what had been a problem of oversupply of PTA.
These are just two examples of attractive themes that we see playing out in the world’s third-biggest fixed income and credit market. In a world of near-zero yields, spiraling debt and rising default risk, we think investors may be surprised at the profile and potential it offers.
And finally, as a firm, we believe China is committed to market liberalization. It has already come a long way, but we think it will likely do more to enable foreign asset managers and banks to participate, and to increase liquidity and transparency, in order to achieve its strategic goal of making its markets, institutions and currency a credible alternative to the dollar, euro and yen markets. That’s why Neuberger Berman has historically been at the vanguard of foreign asset management in China, and, back in 2017, was among the first of five asset managers to be awarded a license to establish a wholly foreign-owned enterprise (WFOE) to manage onshore Chinese assets for onshore Chinese clients.
It may take some effort to climb the Great Wall around China’s onshore bond market—but we believe there is plenty of opportunity on the other side.
In Case You Missed It
- Japan Consumer Price Index: +0.1% year-over-year in June
- Japan Purchasing Managers’ Index (Flash): +3.1 to 43.9 in July
- U.S. Existing Home Sales: +20.7% to SAAR of 4.72 million units in June
- U.S. Initial Jobless Claims: +1.42 million for the week ending July 18
- Eurozone Purchasing Managers’ Index (Flash): +6.3 to 54.8 in July
- U.S. New Home Sales: +13.8% to SAAR of 776,000 units in June
What to Watch For
- Monday, July 27:
- U.S. Durable Goods Orders
- Tuesday, July 28:
- S&P Case-Shiller Home Price Index
- U.S. Consumer Confidence
- Wednesday, July 29:
- FOMC Meeting, Summary of Economic Projections and Press Conference
- Thursday, July 30:
- U.S. 2Q GDP (First Estimate)
- U.S. Initial Jobless Claims
- Friday, July 31:
- Eurozone 2Q GDP (First Estimate)
- U.S. Personal Income and Outlays
Statistics on the Current State of the Market – as of July 24, 2020
|S&P 500 Index||-0.3%||3.8%||0.6%|
|Russell 1000 Index||-0.3%||4.0%||1.0%|
|Russell 1000 Growth Index||-0.7%||3.8%||13.9%|
|Russell 1000 Value Index||0.2%||4.2%||-12.8%|
|Russell 2000 Index||-0.4%||1.9%||-11.4%|
|MSCI World Index||-0.1%||4.2%||-1.5%|
|MSCI EAFE Index||0.4%||4.6%||-7.0%|
|MSCI Emerging Markets Index||0.6%||7.1%||-3.2%|
|STOXX Europe 600||0.3%||5.7%||-7.1%|
|FTSE 100 Index||-2.6%||-0.5%||-17.3%|
|CSI 300 Index||-0.8%||9.0%||11.9%|
|Fixed Income & Currency|
|Citigroup 2-Year Treasury Index||0.0%||0.0%||2.9%|
|Citigroup 10-Year Treasury Index||0.4%||0.7%||13.2%|
|Bloomberg Barclays Municipal Bond Index||0.4%||1.3%||3.4%|
|Bloomberg Barclays US Aggregate Bond Index||0.4%||1.2%||7.4%|
|Bloomberg Barclays Global Aggregate Index||1.1%||2.2%||5.3%|
|S&P/LSTA U.S. Leveraged Loan 100 Index||0.8%||2.4%||-1.6%|
|ICE BofAML U.S. High Yield Index||1.5%||3.9%||-1.1%|
|ICE BofAML Global High Yield Index||1.6%||3.8%||-0.5%|
|JP Morgan EMBI Global Diversified Index||1.3%||3.0%||0.1%|
|JP Morgan GBI-EM Global Diversified Index||1.6%||2.8%||-4.3%|
|U.S. Dollar per British Pounds||2.0%||3.5%||-3.5%|
|U.S. Dollar per Euro||1.8%||3.5%||3.6%|
|U.S. Dollar per Japanese Yen||1.2%||1.9%||2.7%|
|Real & Alternative Assets|
|Alerian MLP Index||1.4%||-2.7%||-37.4%|
|FTSE EPRA/NAREIT North America Index||-0.8%||-1.2%||-21.9%|
|FTSE EPRA/NAREIT Global Index||-0.4%||0.1%||-21.0%|
|Bloomberg Commodity Index||2.5%||4.9%||-15.5%|
|Gold (NYM $/ozt) Continuous Future||4.8%||5.4%||24.6%|
|Crude Oil WTI (NYM $/bbl) Continuous Future||1.3%||5.1%||-32.4%|
Source: FactSet, Neuberger Berman.