The new frontier of
global bond investing

It’s time to rethink China, here’s why

Overview

Having recently lowered its barriers to entry, China’s 17-trillion-dollar bond market* has become too big for investors to ignore. As the world’s second largest economy, China is a major global player and is on a significant trajectory of growth. Yet, despite the size and growth of the market, China is currently under-owned, with foreign investor participation accounting for just over 2% of the entire bond market*. In fact, China offers emerging market like returns for developed market levels of risk.

* Source: Eurizon SLJ Capital & WIND as at 31/12/2020

Emerging markets returns with developed markets risk

Why China?

The Chinese market has recently opened-up to foreign investors, which has, in our view, been the single most important change made to global financial markets since the introduction of the Euro. Bonds are viewed as a save haven in times of market stress and in particular Chinese Bonds have fared remarkably well. This is a market that is too important for investors to ignore.

1. Attractive yields

(Tab 1) China onshore (RMB) bonds offer an attractive yield, relative to developed markets. Occupying the space between emerging and developed markets, RMB bonds offer an alternative source of yield for income investors.

2. Robust historical returns

(Tab 2) The RMB bond market has demonstrated emerging market style returns, outperforming global bond indices and developed markets such as the UK.

Past performance is no guarantee of future returns. Income from investments is variable and not guaranteed.

3. Safe haven
assets

(Tab 3) The RMB bond market has behaved as a safe-haven during times of market stress. At the same time the lower volatility, relative to emerging markets, has helped improve the risk reward characteristics of emerging market indices.

4. Low correlation and
superior risk/reward

(Tab 4) Over the last 15 years, RMB bonds have outperformed emerging market debt, global bonds and UK gilts on a risk adjusted basis.

The second largest bond market in the world

The opportunity is now

- With over USD 17 trillion* (as at 31/01/2021), the Chinese market is the second biggest bond and equity market worldwide, and on a significant trajectory of growth.

- Yet, China is currently under-owned, with foreign investor participation accounting for only 3% of the entire bond market.

- China has recently been opening to foreign investors with key policies and reforms, and the recent inclusion of Chinese bonds into global indices will bring even larger inflows, forecasted to reach USD 2 trillion in 5 years.

- However, even though China’s share in global indices is rising, the imbalance between market size and index weight will persist, making the case for an active allocation into China bond market even more compelling.

*Source: WIND & Eurizon SLJ Capital

Figures are shown in (USD)

Past performance is no guarantee of future returns
Sources: Bond Market size - BIS Q2 2020
Nominal GDP, PP Adjusted GDP and Annual Growth % - The World Bank, as of 31/12/2019

Local expertise with a global perspective

The right investment manager

Our RMB bond portfolio managers are all Chinese native, fluent in Mandarin and have studied and now live in the West. We believe this represents a double strategic advantage, not only in accessing local language information and intel, understanding the local cultural nuances and policy decisions, but also in gaining a better understanding of the global economy and the global context in which to think about China.

Macro research is at the heart of our company culture and investment process. Our top-down discretional investment approach is based on our understanding of the peculiarities of the Chinese economy and its increasing relevance in determining global economic and political trends.

Team experience: Percentage of time spend living or working in region

Sources: Eurizon SLJ Capital Ltd, as of 01/02/2021

Research led idea generation

We believe that our research-led active management approach offers the best opportunity to exploit inefficiencies inherent within emerging, currency and fixed income markets with the potential to add incremental value in a risk-aware manner.

Explore the sections below to read a sample of our insights:

China’s 14th Five Year Plan

November 4, 2020 - By Marilyn Che and Monica Wang

The fifth plenary session of the 19th Chinese Communist Party (CPC) Central Committee was held from October 26-29. The outline of the 14th Five-Year Plan (FYP), as well as longer range policy targets leading up to 2035 were announced. These are the broad economic development goals the Communist Party has set for the nation. Further details are expected to be released at the National People’s Congress (NPC) (which will be the national government’s key policy gathering) in March 2021, when the NPC will also be expected to approve the FYP. For the first time, China has not mentioned a GDP target in a FYP. Instead, the quality of growth is the emphasis. The focusses of the 14th FYP are as following.

Technological innovations. Beijing has put technological innovations as a top priority. China aims to innovate core technologies, partly in response to the increased tensions with the US which have exposed China’s vulnerabilities from its heavy reliance on imported high tech products, such as semiconductors.
To cultivate “dual circulation” with a focus on boosting domestic consumption (‘internal circulation’). In this regime, the internal circulation will be centred on domestic consumption and import substitution. Boosting consumption will be accompanied by an expansion of domestic supply to satiate this greater consumption demand.
To maintain a high intensity in reforms and liberalisation of both the financial markets and the real economy.
To promote a green economy. President Xi’s declaration at the United Nations for China to achieve carbon neutrality by 2060, a decade later than the goal set by many other countries, was a pleasant surprise and could form the foundation for cooperation between China and Europe.
The industrial upgrading. The industrial upgrading includes manufacturing upgrading, high-quality supply and digital economic development with an aim to push Chinese firms up in the global value chain.

As for the long-term overarching goal, China is aiming to become a moderately developed country by 2035 with GDP per capita of USD 25K.

In sum, the commitment to quality growth prioritizes the internal/domestic development and innovation, with negative implications for other economies (some EM) in the ecosystem centred on China. The reforms and the focus on the quality of growth should mean a deceleration in the headline growth rate of China over the medium- and long-term, following rapid recovery in the near term. This is the ‘L-shaped’ economic trajectory we have had in mind for some time.

E-CNY - What you need to know

January 25, 2021 - By Stephen Li Jen and Joana Freire

The Chinese RMB is going digital. Beijing has begun to experiment, in a limited trial in four cities, with the use of e-CNY. While the PBOC is the first central bank officially (soft) launching an e-currency, some 80 percent of the central banks around the world are studying the viability, practicality, and implications of issuing their own digital currencies.

(1) These e-currencies issued by central banks (called central bank digital currencies, or CBDCs) are distinguished from cryptocurrencies in the former’s lack of anonymity. In the case of the e-CNY, the PBOC will use blockchain technology to trace the owners and the uses of each e-CNY issued, i.e., the entire trail of transactions of each e-CNY – precisely the opposite of the goal of Bitcoin of decentralised anonymity.

(2) The PBOC has ambitious goals for the e-CNY outside China: that it will be a Chinese currency that other countries could use to bypass the dollar or the reliance on the US’ SWIFT payments system. However, the e-CNY faces the challenge of convertibility.

(3) Since the e-CNY will be issued as a substitute for cash, i.e., non-interest bearing, it is not expected to pose serious competition for interest paying bank deposits but could provide benefits (e.g., efficiency, coverage, and real time data) that notes and coins cannot offer. In contrast, since much of the developed world has zero interest rates on bank deposits, e-currencies would be a major competition to their banks.

(4) Successful development of the e-CNY could help enhance CNY’s international and reserve currency status, at the expense of the USD, the EUR, the JPY, and the GBP. But we do not believe this innovation would be sufficient to supplant the dollar’s hegemonic position in the world, since the Fed could and probably will also issue e-dollars one day.

Bottom line

China invented fiat money in the 7th century, and, in the 11th century, the government monopolised currency issuance. It is, thus, fitting that the PBOC is the first major central bank to introduce an e-currency. We believe others will follow, including the Fed and the ECB. The invention of fiat monies gave governments enormous power.

In many ways, the innovations in the issuance of sovereign fiat monies have lagged behind e-commerce, and central banks now run the risk of an erosion in seigniorage if they themselves are disintermediated. We see the CBDCs as a countermeasure to the rise of cryptocurrencies, with a key advantage being the former’s low volatility. CBDCs will likely win in the end as the dominant media of exchange, unit of account, and store of value.

The e-CNY has several advantages, but has also features that might be considered flaws, like the outstanding question about convertibility outside China. The Fed, the ECB, and other central banks will likely also issue their own CBDCs in the coming years, presumably with their own distinguishing traits and technological features (such as anonymity and the ability to confiscate the e-currency in certain situations), which could have implications for how popular they are as international currencies and the transmission mechanism of monetary policies. In the coming years, it will be most interesting to track the various CBDCs as they are developed.

RMB Bonds: 2021 Outlook

January 18, 2021 - By Stephen, Monica, Marilyn, and Wenting

...The Chinese economy has performed well and the momentum will carry over into 2021

Just like the rest of the world, Beijing had to shut down the entire economy to contain the spread of the Virus. The difference from other countries is how early and intensely China administered the shutdown. Beijing was able to achieve success in virus containment due to its fundamental political structure, the conformist nature of its citizenry, and its prior experiences with SARS (2002-04).

Broad financial support was delivered to the economy through various channels (transfers as well as utility fee holidays and cuts in fees for services rendered by SOEs). Demand was stabilized and the time during which the economy had to be shut was compressed.

The ensuing economic recovery in H2 2020 was powered primarily by industrial production and exports. Retail sales and many services remain weak. This configuration of aggregate demand is logical. What is remarkable is how well Chinese exports performed, when the rest of the world’s production had to be shut down, allowing Chinese exporters to meet the world’s demand when local production ceased.

While this situation will of course not persist, as the rest of the world is gradually and haphazardly normalizing and recovering, China should continue to enjoy strong export demand for a few months longer, we think. At the same time, as China’s own domestic demand recovers and as the rest of the world’s supply comes back on stream, we expect China’s surge in trade surplus to abate, and the drivers of the economy move from industrial production and exports to consumption.

Headline growth for 2021 could reach 8.0%, reflecting the low-base effect of 2020. But incremental GDP growth will decelerate in the year, reverting back to the structural trend deceleration in growth toward 5.0% or so over the medium-term.

In stark contrast of all of the developed countries, China’s financial policies are devised with a multi-cycle perspective: policies today are aimed at the optimal outcome over multiple cycles and not just the current cycle. Like the Bundesbank, the PBOC is of the view that many of the policies that may be justified to deal with the urgent current conditions may not be optimal over time, because of the negative side effects that may create problems further down the road. This is why the PBOC has stayed ‘neutral’ with its monetary policy. The fiscal stance is similarly conservative.

We have called the PBOC the ‘Bundesbank of Asia’ for this reason.

The 14^th Five Year Plan has made it clear that much of the policy focus will be on how best to transform the structure of the Chinese economy, and not just to eke out the maximum headline growth rate in each quarter. The economy will be upgraded through technology; the financial sector will continue to be reformed and cleansed to be more resilient; and the environment will now also be a policy consideration. All of these initiatives point to higher quality of growth in the coming years, even if the headline growth rate declines somewhat...

Bottom line

We have a favourable outlook for the Chinese bond market in 2021. Growth will likely trace out an arc, marking a peak in incremental growth, followed by a meaningful deceleration in the headline incremental GDP growth rate. At the same time, the RMB should continue to enjoy support from a favourable balance of payments position as well as China’s superior economic fundamentals. Absent major economic or political shocks, foreign capital should continue to flow into China’s newly opened bond and equity markets.

This information is an excerpt from the Eurizon SLJ RMB Bonds 2021 Outlook.

The content is for information purposes only and is targeted solely to institutional investors.

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Disclosure

Past performance is no guarantee of future performance. The value of the investment and the resulting return are subject to fluctuations, may increase as well as decrease and, at the time of redemption, the investor may not get back the financial investment.

This communication is intended for professional investors.
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The new frontier of global bond investing

Overview

Emerging markets returns with developed markets risk

Why China?

1. Attractive yields

2. Robust historical returns

Past performance is no guarantee of future returns. Income from investments is variable and not guaranteed.

3. Safe havenassets

4. Low correlation and superior risk/reward

The second largest bond market in the world

The opportunity is now

Figures are shown in (USD)

Past performance is no guarantee of future returnsSources: Bond Market size - BIS Q2 2020Nominal GDP, PP Adjusted GDP and Annual Growth % - The World Bank, as of 31/12/2019

Local expertise with a global perspective

The right investment manager

Team experience: Percentage of time spend living or working in region

Sources: Eurizon SLJ Capital Ltd, as of 01/02/2021

Contact Form

Disclosure

Past performance is no guarantee of future performance. The value of the investment and the resulting return are subject to fluctuations, may increase as well as decrease and, at the time of redemption, the investor may not get back the financial investment.

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The new frontier of
global bond investing

3. Safe haven
assets

4. Low correlation and
superior risk/reward

Past performance is no guarantee of future returns
Sources: Bond Market size - BIS Q2 2020
Nominal GDP, PP Adjusted GDP and Annual Growth % - The World Bank, as of 31/12/2019