How to Tap on the Long-Term Potential of China Bonds

China bonds have established and solidified themselves as an asset class amongst institutional investors. According to the Bank of International Settlements, China is now the second-largest issuer of bonds in the world.^ In 2022, China accounted for US$20.9 trillion worth of bonds, behind the US (US$51.3 trillion), and ahead of Japan (US$11 trillion). China’s rise as a global debt issuer is impressive, considering its bond markets clocked at just US$3.1 trillion in 2010. The growth was especially robust in the last three years when the Chinese bond markets grew by 13% annually. Today, China holds a 16% share of the global bond market.

These are significant achievements and render China bonds worthy of a second look. But with the ongoing uncertainties surrounding the Chinese (and the global) economy, how should retail investors approach China bonds to unlock their long-term potential?

^Source: https://www.visualcapitalist.com/ranked-the-largest-bond-markets-in-the-world/

China Bonds — More Than Just Real Estate Bonds

First off, let’s address the elephant in the room. Whenever the term “China bonds” are mentioned these days, it’s almost always in the context of defaults. More worryingly, the defaults are from Chinese real estate giants like Evergrande and Country Garden.

However, the Chinese bond market is much more than real estate bonds. China property bonds are issued by the private sector, and only represent part of the Chinese bond market.

On the other end of the spectrum are government-issued debt securities such as China Government Bonds (CGBs) and China Policy Bank Bonds.

Given the current state of the Chinese real estate sector, we believe that the long-term potential of China bonds may tilt in favour of CGBs and China Policy Bank Bonds. And that is where we will be focusing our attention for the remainder of the article.

With that out of the way, let’s take a deeper look at why we might invest in China bonds.

Source: Unsplash

Why Invest in China Bonds?

China’s near-term economic outlook may be worrisome, but in our opinion, its economic fundamentals remain robust. There are short-term challenges such as continued depreciation of the renminbi against the US Dollar; heightened volatility in equities; and continued weakness in the real estate sector in the absence of stronger government measures, but the country is far from being down and out.

Nor is China headed for a Japan-style “Lost Decades” period, despite what many YouTubers may proclaim. The main differences here are the much higher potential GDP (Gross Domestic Product) growth rate for China; comparatively modest asset inflation levels; and lax policy environment with room for further easing.

Additionally, the country has a growth outlook that outstrips most major economies — according to the IMF (International Monetary Fund), China’s GDP is expected to grow 4.5% in 2024 (vs US: 1% and Global: 3%).

So, while things may appear dire right now, we believe that China’s long-term prospects remain strong. Investors seeking long-term growth in the Chinese market can potentially look to CGBs and China Policy Bank bonds for safer and more stable returns.

Pros and Cons of China Bonds

CGBs and China Policy Bank bonds are investment-grade bonds issued and backed by the Chinese government. They are well-supported by domestic demand, and foreign demand — while cooler due to recent geopolitical developments — we think it is also expected to rebound in the coming years.

Historically, China bonds have also displayed a low correlation to its foreign counterparts. While the US and other jurisdictions are grappling with interest rate hikes, China’s economic policy seems to be headed in the opposite direction. Thus, China bonds may bring both diversity and stability to a bond portfolio.

It’s also important to consider the flipside. Like all bonds, China bonds carry the risk of default, no matter how low, and investors should be cognisant of the investment risk they bear. Another potential downside is liquidity risk; as China’s bond market is not as mature and developed, liquidity may be low. In some cases, liquidity may also be unevenly distributed, resulting in shorter-duration bonds being more liquid than longer ones.

Furthermore, China bonds currently offer lower yields than other more mature economies. This is likely because the People’s Bank of China (PBOC) unexpectedly cut interest rates for the second time in three months back in August 2023, in an attempt to boost the Chinese economy in the short run.

This is in contrast to other central banks who have been progressively raising and holding interest rates to fight their high levels of inflation. This divergence in monetary policy between China and other major economies has resulted in relatively laggard China bond yields.

6-month CGBs have a yield of 2.360% p.a. (as of 25 October 2023). This is in constrast to 6-month US Treasury Bills which offer a yield of 5.54% p.a. (as of 27 October 2023) or even 6-month Singapore Treasury Bills that offer a yield of 3.91% p.a. (as of 26 October 2023). If your primary concern as a bond investor is purchasing bonds with the highest yield, you might want to hold off investing in China bonds and instead invest in US or Singapore Treasury Bills in the immediate future.

Differences Between China Government Bonds (CGBs), China Policy Bank Bonds, and China Property Bonds

Given what is happening in the China property sector right now, the man on the street may associate the China Bond asset class only with the property sector bonds and think that the entire asset class is high-risk, volatile, and runs a high probability of default.

However, China bonds also include China Government Bonds and China Policy Bank Bonds, which lie on the other end of the spectrum — they are widely considered a safer category as they are backed by the Chinese Government. These investment-grade bonds are low in volatility and well supported by domestic demand.

In other words, despite the real headwinds China is facing now, China Bonds as an asset class consists of other types of bonds that are more secure and less volatile than the property sector bonds. Therefore, the case for China Government Bonds and China Policy Bank Bonds still remain positive against the more sombre outlook for property sector bonds.

(NikkoAM’s ETF represents the latter two bonds, which makes it a good portfolio diversifier.)

Below is a table that showcases the differences between the three types of China bonds.

Source: Unsplash

How to Invest in China Bonds

Via ETFs

Exchange-traded funds (ETFs) are investment funds composed of a basket of different securities or assets. They attempt to replicate the performance of the underlying benchmark, allowing investors to gain exposure to inherent opportunities present in the relevant markets.

For China bonds, consider the NikkoAM-ICBCSG China Bond ETF. This fund tracks the ChinaBond ICBC 1-10 Year Treasury and Policy Bank Bond Index, capturing a healthy segment of the Chinese bond market.

The investment objective of the Fund is to achieve long term capital growth by replicating the returns of the ChinaBond ICBC 1-10 Year Treasury and Policy Bank Bond Index (the “Index”).

The Fund will offer to investors a Chinese bond investment universe that is increasingly growing in size and foreign participation. It invests in bonds issued by:

In other words, the NikkoAM-ICBCSG China Bond ETF focuses on good quality bonds backed by the Chinese Government. Also, longer-term systemic risks are kept out by focusing on bonds with durations of up to 10 years.

Via a Regular Savings Plan (RSP)

A regular saving plan is a plan where you invest a fixed sum at regular intervals into your choice of investment.

The amount deposited is used to purchase units in China bond funds, allowing your portfolio to build up over time. You can also cash out your investment partially or in full by selling off the units in your portfolio.

Regular savings plans are essentially a dollar-cost averaging (DCA) investment strategy that allows you to ride out market volatility over time. Another advantage is the relatively low starting capital – you can start investing in a regular savings plan from as little as S$100.

NikkoAM-ICBCSG China Bond ETF is available via participating dealers, as follows:

Participating dealers

Interested in investing in the China bond market? Find out more about NikkoAM-ICBCSG China Bond ETF – SGD Class, and how it could potentially fit into your investment goals.

This post was sponsored by and written in collaboration with Nikko Asset Management. ValueChampion (part of AMTD PolicyPal) remains committed to maintaining our editorial integrity by providing the most accurate information and reviewing products with an objective lens. We strive to be an unbiased source of news and content, and are dedicated to helping our readers in their financial wellness journey.

Important Information by Nikko Asset Management Asia Limited:

This document is purely for informational purposes only with no consideration given to the specific investment objective, financial situation and particular needs of any specific person. It should not be relied upon as financial advice. Any securities mentioned herein are for illustration purposes only and should not be construed as a recommendation for investment. You should seek advice from a financial adviser before making any investment. In the event that you choose not to do so, you should consider whether the investment selected is suitable for you. Investments in funds are not deposits in, obligations of, or guaranteed or insured by Nikko Asset Management Asia Limited (“Nikko AM Asia”).

Past performance or any prediction, projection or forecast is not indicative of future performance. The Fund or any underlying fund may use or invest in financial derivative instruments. The value of units and income from them may fall or rise. Investments in the Fund are subject to investment risks, including the possible loss of principal amount invested. You should read the relevant prospectus (including the risk warnings) and product highlights sheet of the Fund, which are available and may be obtained from appointed distributors of Nikko AM Asia or our website (www.nikkoam.com.sg) before deciding whether to invest in the Fund.

The information contained herein may not be copied, reproduced or redistributed without the express consent of Nikko AM Asia. While reasonable care has been taken to ensure the accuracy of the information as at the date of publication, Nikko AM Asia does not give any warranty or representation, either express or implied, and expressly disclaims liability for any errors or omissions. Information may be subject to change without notice. Nikko AM Asia accepts no liability for any loss, indirect or consequential damages, arising from any use of or reliance on this document. This advertisement has not been reviewed by the Monetary Authority of Singapore.

The performance of the ETF’s price on the Singapore Exchange Securities Trading Limited (“SGX-ST”) may be different from the net asset value per unit of the ETF. The ETF may also be suspended or delisted from the SGX-ST. Listing of the units does not guarantee a liquid market for the units. Investors should note that the ETF differs from a typical unit trust and units may only be created or redeemed directly by a participating dealer in large creation or redemption units.

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