Just over a year after the Covid-19 outbreak began causing economic turmoil around the world, it appears investors may have discovered a new defensive asset: Chinese renminbi debt.
The USD16 trillion bond market has come through the crisis exhibiting the sort of stability normally associated with benchmark US Treasuries.
Not only did it hold up better than developed market government bonds during a tumultuous first quarter of 2020, it has also since traded within much narrower ranges. Its potential as a risk mitigation tool has also been thrown into sharp relief.
Over the past several months, renminbi bonds have not moved in lockstep with the world's other major bond markets. Neither have they tracked emerging market assets. All of which suggests they could turn out to be a good hedge against the riskier assets investors hold in their portfolios.
One explanation for this new-found resilience is that reforms in China have allowed renminbi-denominated bonds to feature more prominently in mainstream global bond benchmarks.
In March, FTSE Russell announced Chinese government bonds will be included in its flagship benchmark indices. That came on the heels of similar moves by JP Morgan and Bloomberg-Barclays.
Index inclusions are landmark developments, both for China and for investors worldwide.
For authorities in Beijing, they are a stamp of approval for their efforts to liberalise the country's capital market and integrate more fully into the international financial system.
For investors, it opens up a new world – one where the renminbi becomes a genuinely global investment currency. In other words, China's onshore bond market will play a far greater role in international bond portfolios.
China's USD16 trillion onshore bond market will play a far greater role in bond portfolios.
Foreign ownership of Chinese bonds was already rising in anticipation of the index changes.
Non-Chinese investors built up their holdings of RMB debt to RMB3.2 trillion by December 2020, up nearly 50 per cent from the same month a year before.1
Of the USD9.5 trillion of assets under management from corporate and public pension funds globally, 0.26 per cent was held in Chinese bonds as of the third quarter of 2020, up from 0.04 per cent in 2015.2
Further boosting the market's international standing, China has delivered a series of reforms to make it easier for foreigners to access the market.
Among the most important, the “Bond Connect” programme, launched in 2017, allows non-Chinese investors to trade in Hong Kong without an onshore account. Already, 75 out of the world’s top 100 asset managers have joined the programme while trading volume doubled last year to RMB4.8 trillion.3
All of which means the inflows seen since the pandemic are likely to be part of a much larger reallocation. According to the International Monetary Fund, index inclusion alone could result in capital inflows of as much as RMB7.4 trillion into Chinese bonds from international investors.
Going green
Another favourable development is China’s recent announcement that it plans to be carbon neutral by 2060.
The ambitious goal is likely to require as much as USD16 trillion of investments, where we believe green bonds will be an important channel.
The PBOC has already promised to improve the country’s green finance standards to support the 2060 goal and make it easier for foreign investors to enter the green finance market.
As of June 2020, China’s outstanding green bonds totalled RMB1.2 trillion, the second largest in the world.
This figure should grow in the coming years, helping expand the universe and increase the depth of the Chinese onshore bond market in the long term.
RMB-denominated bonds should become an even more integral part of global fixed income investors’ portfolio.
With its population ageing rapidly and its investment needs rising as a consequence, China has every incentive to remove restrictions on the flow of capital across its borders and drawing in foreign funds.
And nowhere other than the RMB onshore bond market can investors see China’s economic transformation more clearly in the coming years.
As the year of the Ox promises to bring growth for Chinese RMB-denominated bonds, the asset class should become an even more integral part of global fixed income investors’ portfolio.
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