In 2019, China surpassed Japan to become the second largest bond market in the world. According to the report of the National Finance and Development Laboratory of the Chinese Academy of Social Sciences, the aggregate value of the bonds issued in China reached 12.02 trillion yuan in the first quarter of 2020, a year-on-year growth of 15.73%. As of the end of the first quarter, the size of the bond market exceeded 100 trillion yuan.
However, compared with the United States, the world's largest bond market, the Chinese market at this stage has a significant feature in that it offers mostly short-term bonds, especially bonds with a one-year or shorter maturity. These account for the majority of the market share, leaving a relatively low proportion for medium- and long-term bonds.
Medium- and long-term bonds, however, play an important role in maintaining stable bond market supply and meeting the diverse needs of domestic and foreign investors; and the investment of more medium- and long-term investors will in turn promote the steady development of the bond market.
At the end of June, Euromoney colleagues from our Asian Global Capital office joined three experts from the National Social Security Fund Council, China Southern Asset Management and BlackRock for an online roundtable discussion on ways to develop mid- and long-term investment ideas in order to meet investor needs and encourage foreign investment in China's bond market.
Chinese fund companies embracing longer-term investment
Li Haipeng, Deputy General Manager and Chief Investment Officer (fixed income) of China Southern Asset Management, said that there has been a positive response in recent years from both regulators and market participants to the concept of medium- and long-term investment.
Taking China Southern Asset Management as an example, the internal evaluation of the fund's performance continues to tilt more positively toward mid- and long-term bond investment, and the weight assigned to one-year, three-year, and five-year bonds’ performance was 20%, 30% and 50%, respectively.
Li Haipeng said that in addition to yield, the company also paid more attention to the assessment of other indicators, such as volatility and drawdown. “If fund managers want to control drawdown, they will pay more attention to long-term stable growth instead of short-term gains.”
At the same time, Li Haipeng said that as China's population ages and the overall risk appetite of the public shrinks, investors will be more willing to invest in the bond market in the medium- and long-term, which will help change the investment philosophy of fund companies.
Regarding the supply of medium- and long-term bonds, Li Haipeng believes that, with the issuance of special treasury bonds this year, it can be expected that more medium- and long-term bonds will be issued in the future to expand market capacity and improve market liquidity. “This way we will have more flexibility when investing,” he said.
Data from China Bond showed that in 2019, the issuance volume of bonds with maturity of 7-10 years and longer than 10 years increased respectively by 38.59% and 230.10% year-on-year. From January to May 2020, the numbers increased 30.62% and 320.6% respectively.
The market expects more medium- and long-term products
Li Na, Director of the Fund Finance Department of the National Social Security Fund Council, believes that with the increased demand from pension funds, the current supply of long-term products in the investment market is inadequate, and the existing target-term products have an insignificant term premium.
“If an investor invests in a 30-35 year product and finds that the return is actually not much higher than a 3-6-month product, and on top of that, liquidity is forgone for a long period, then this is a negative incentive.”
Li Na believes that this phenomenon exists mainly because of the competition from the “low-hanging fruits” in the Chinese market – that is, there are large numbers of high-yield short-term investment opportunities out there for easy reach. As the domestic bond market moves forward with better maturity and efficiency, against a background of declining interest rates, medium- and long-term investment products will gradually demonstrate their premium advantages.
In addition to target-term funds, more and more bond index fund products have appeared in the market. At present, this type of index mainly tracks short- and medium-term bonds, but Li Haipeng of China Southern Asset Management believes that the size of long-term bond index funds will gradually increase in the future as the economic cycle changes.
“Our goal is to provide a basket of products covering different maturities. At present, short-term bonds such as financial bonds and policy financial bonds account for a larger proportion of the bond indices, mainly because of their size and liquidity.
“Also, from the investors’ perspective the price/performance ratio is relatively good,” he added, “but from a historical perspective, I believe that, in a different cycle, the demand for long-term bonds of 7-10 years will increase significantly.”
In this regard, Eric Liu, BlackRock’s head of fixed income in Asia, said that improving the liquidity of medium- and long-term bonds in the market will benefit both short-term and long-term products. “Some short-term funds also invest in long-term bonds because they are more liquid overseas. For example, 10-year bonds are often the most liquid. If domestic short- and medium-term investors are more willing to participate in long-term bond investments, it will improve the liquidity of China’s long-term bonds and will help increase market demand dramatically.”
Foreign capital needs to enter China’s market step-by-step
At present, the proportion of overseas investor holdings in the Chinese bond market is below 5%, but as China's financial reform and opening up continues, it is likely that more foreign capital will enter in the future.
“After the world’s three major bond indexes included China's government bonds and policy financial bonds, foreign investors are increasingly interested in the Chinese market,” said Eric Liu from BlackRock. “The amount of foreign capital inflows in 2019 was not as high as we had imagined, mainly due to Sino-US trade conflicts and exchange rate issues. This year we also had some withdrawals of foreign capital in March and April, but this is not to say that foreign capital has lost interest in China’s market. Rather, such withdrawals were forced by the liquidity crisis of the US dollar.”
Liu said that, as the liquidity in the US dollar capital market eases and the RMB exchange rate remains stable – and the interest rate spreads between the US and China continues to widen – foreign capital inflows into the Chinese bond market will continue to grow. He also believes that if investors overseas benefit from more trading opportunities and conveniences for currency and interest rate hedging, their enthusiasm for investing in China will also be fueled in a significant way.
In this regard, Li Haipeng from China Southern Asset Management believes that foreign investors can consider a progressive plan for China's bond market.
“For example, in the first step they can focus on investing in the bonds issued by large Chinese enterprises, especially the central SOEs; the second type of bonds that merits their attention is urban investment bonds issued by the developed areas of the country, some of which are similar to muni bonds of other countries. As they get to know more about the Chinese bond market, they can gradually shift their focus onto ordinary state-owned enterprises or high-quality private enterprises.”
“Of course, in the third step, I recommend investing in China’s high-yield bond market. This is a market in which domestic institutions are currently investing.”