At $10.5 trillion, China’s bond market was the world's third largest, behind the US and Japan. Given the size and growth trajectory of China’s onshore bond market, we believe there is scope for foreign investors to participate more heavily in it and for the asset class to potentially play a bigger role in global bond portfolios.
Foreign investors have historically participated in China’s bond market via the smaller offshore segment of the market, which has a higher penetration level than the onshore market, where foreign ownership remains low because of limited accessibility in past years.
Despite its colossal size relative to the offshore market, the total net assets within the RMB bond-onshore Morningstar Category, that contains funds that invest mainly in CNY-denominated credits, is still just a fraction the size of the renminbi bond and renminbi high-yield bond categories combined, which contain funds that invest predominantly in US dollar- and offshore yuan-denominated credits.
Investor’s Appetite Limited
We have seen investors' appetite for dedicated renminbi bond funds wane over the years. For example, the total net assets of funds domiciled in Europe, Africa, or Asia across the renminbi bond, renminbi high-yield bond, and renminbi bond-onshore Morningstar Categories stands at $3.1 billion, representing a mere 0.03% of China bond market’s outstanding value.
Funds across all three categories saw strong aggregate net inflows of $3.7 billion between December 2012 and July 2015. However, the Chinese central bank’s surprise devaluation of its currency in August 2015 caused investor sentiment to turn negative, as renminbi bond funds saw massive outflow of $1.5 billion that month. Since then, investor’s appetite for renminbi bonds has continued to remain weak.
Market Has Become More Accessible
In recent years, the Chinese government has taken numerous steps to increase accessibility of the onshore bond market to foreign investors. In February 2016, the central bank announced the total elimination of quotas, allowing foreign banks, insurance companies, asset managers, and pension and endowment funds to invest in the interbank bond market with repatriation limits.
In July 2017, the Hong Kong-China bond connect scheme was launched to allow foreign institutional investors to trade in the onshore bond market without repatriation limit . The scheme commenced with ”northbound” trading, allowing foreign investors to trade onshore Chinese bonds, while “southbound” trading, which will allow Chinese investors to trade Hong Kong and overseas bonds, is yet to be announced.
Other plausible tailwinds for the asset class include: 1) potential inclusion of onshore renminbi bonds in global bond indexes, which could fuel inflows into passive funds. 2) In October 2016, the International Monetary Fund added the RMB to its basket of reserve currencies in its Special Drawing Rights basket, which will likely see the currency feature more prominently in global trade.
We believe these developments will potentially drive greater accessibility and investor demand for the asset class.
Renminbi bonds are still widely regarded by many investors as a niche asset class and continues to be in a transitionary phase. However, as accessibility improves and asset managers dedicate more resources to the asset class, we believe that the continued growth of renminbi bonds will broaden the investable universe for emerging-markets and global local-currency bond funds. As a result, asset managers are able to leverage this additional alpha source, if and when they deem appropriate, and diversify their portfolio, potentially delivering better outcomes for investors.
