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June 21, 2022  |  8 Minute Read

By: Julia Rees, CFA, Romain Duvergé


A truly epochal event is well underway in capital markets: the integration of China government bonds (CGB) into the investment mainstream. Despite the country’s economic ascendancy, China’s closed capital account and the difficulties of accessing its financial markets had historically constrained foreign investment into the nation’s bond and equity markets. The subsequent financial liberalization efforts China has undergone are paying off, leading to rapidly increasing weights for CGBs in the key benchmark indices and accompanying inflows.


Specifically, CGBs now make up over 8% of the Bloomberg Global Aggregate Bond Index, after an inclusion process that ran from April 2019 to November 2020. Over the span of 2020, the level of CGBs in the JPMorgan GBI-EM Index reached 10%. A third active and passive flow opportunity is ongoing, as the FTSE World Government Bond Index started including CGBs on October 2021 and is expected to reach 5.6% by September 2024. We believe these changes are a hugely significant reconfiguration of the world’s major fixed income benchmarks.


China’s total bond market is the world’s second largest, and its government bond market is the third largest globally, commanding more capital than that of Germany, France, and Spain combined1. Given the prominence of these bond benchmarks in many investors’ portfolios, passive and active investors alike will be expressing views on China bonds, intentionally or not.


Impact on risk-taking budgets


While the benchmarks have changed rapidly, active investor portfolios have changed more slowly, or not at all. For example, many active managers had simply accepted the tracking error to the Bloomberg Global Aggregate Bond Index that comes with owning 0% China bonds. The operational difficulty of buying China bonds directly likely contributed to this inertia. However, as the proportion of China bonds in that index grew from about 2% at that time to over 8% now, the magnitude of the active decision to not own Chinese bonds grew as well.


Tracking error, the standard deviation of the excess return of a portfolio to its benchmark, quantifies that magnitude. We estimate that owning 0% Chinese bonds, which we assume as equivalent to a conservative 6% underweight to Chinese government bonds, would drive a 0.32% tracking error. This single decision consumes 20% of the total active risk that a typical active core bond manager is granted to allocate. Translating tracking error into a range of outcomes, we might expect 68% of the deviations from the benchmark due to this underweight to fall within +/- 0.32%, and 95% of deviations to fall within twice that range, or +/- 0.64%1. Government fixed income is a space in which excellence and rankings may be decided by basis points, so this magnitude of deviation from the benchmark is meaningful. The table shows other trades that drive similar amounts of tracking error, despite being larger or more complex.


For example, imagine a global aggregate portfolio manager implements the first trade in the table after forming fundamental views through thoughtful research. Such a combination of intentional investment views may drive a 0.28% tracking error - slightly less than the amount a 0% China bonds position drives, even though the China bond position may be driven more by inertia than by fundamentals.


How Risky is it to Ignore China Bonds in a Global Aggregate Bond Portfolio?


Source: Goldman Sachs Asset Management Strategic Advisory Solutions. The portfolio risk management process includes an effort to monitor and manage risk, but does not imply low risk. For illustrative purposes only. *Chinese government bond underweight using data from Bloomberg Global Aggregate Index and FTSE Goldman Sachs China Government Bond Index since inception of that index in Feb 2014 through April 2019 when the process of including Chinese government debt began, using daily data. Assumes weight for China bonds in index is around 6% which is a conservative figure for investors who track the Bloomberg Global Aggregate bond index but more reasonable for investors who track the FTSE World Government Bond Index. Other trades using monthly data since 2002 due to longer index availability.



We believe China bonds’ significant impact on active risk-taking highlights the necessity for portfolio managers and CIOs to find an implementation option for China bonds, lest they dilute their ability to express active views or even break out of their tracking error bands. Portfolio managers can buy China bonds directly via Bond Connect, or they can use a China bond pooled vehicle The direct route requires a lengthy account-opening process, onshore custodian costs, legal costs, and compliance costs for each and every vehicle or account managed.


Similarly, if you are a fund selector, have you asked your asset manager “what’s your view on China bonds, as it is a significant driver of active risk and return?”  From discussion with many portfolio managers, they usually have an investment basis for going 10% overweight corporates, and in our view they should have an investment basis for going 6% underweight China bonds.


We believe a 0% allocation to China bonds in a core bond allocation is analogous to a 0% allocation to UK equities in a global developed equity allocation, as they are both about 6% of the benchmark index. 0% is as bearish as a long-only manager can be on China, and such a position is likely to be interpreted as an intentional investment view because widely-available ETF implementations exist for China bonds.


A Macro Perspective 


A look at China’s economic heft puts context around how index committees and investors alike get comfortable with the idea of owning meaningful Chinese exposures via index inclusion. China contributed 29%3 of global GDP growth on a purchasing power parity basis in 2019, as much as all developed nations. Since, China has recovered to pre-COVID levels of GDP notably rapidly. Asia’s contribution to global GDP on a PPP basis crossed 50% in 20204. Statistics like these reinforce the impression of the global financial center of gravity moving eastward.


Another group taking notice of China’s increased international flows and influence are reserve mangers. China has the third largest weight in the International Monetary Fund’s (IMF’s) special drawing rights (SDR) basket at 10.9%, second to the USD at 41.7% and the Euro at 30.9%. This basket of major currencies, USD, EUR, JPY, GBP, and CNY acts as a stable asset in countries’ international reserves and is an accounting unit for IMF transactions with member countries. The disparity between China’s weight in the SDR basket and the current weight of CNY in official foreign exchange reserves leads to the possibility of significant future growth in demand.


China in a Multi-Asset Portfolio


Due to index inclusion, portfolios ranging from basic to diversified have significant exposure to Chinese bonds and equities, a marked increase from 2019 pre-inclusion. For example, a basic balanced portfolio with 50% global aggregate fixed income has as of March 2022 around 4% of China bonds from global aggregate- benchmarked assets. If an investor held 9% emerging market equities, they would already own about 3% China equities5.


CGBs diversify global aggregate bonds and Chinese equities, as seen by their close to 0 correlationsof 0.15 and -0.24, respectively. Within global government bond markets, China exhibits low correlations ranging from [0.10;0.25] with the US, UK, Germany, and Japan.


Nearly all investment grade government bond real yields are below 0%, with 33 out of 41 investment-grade countries having negative real 10-year sovereign bond yields7. Compared to these other major economies, Chinese real yields are highly attractive, and the few countries with higher real yields have weaker credit ratings. At A1, China sits in the middle of the investment grade spectrum.


CGBs also have a lower realized volatility (in local currency) than US Treasuries or UK Gilts. The fact that foreign ownership while increasing was still low over the period studied (Dec-2016 to Dec-2021) may bias that realized volatility figure downward. Additionally, domestic Chinese investors tend to buy government bonds and hold them to maturity, which leads both to lower liquidity on the secondary market and perhaps fewer buying/selling reactions around major market events. However, there is reason to be optimistic given CGBs have been resilient and delivered attractive performances during both the Evergrande crisis in 2021 and the Russia’s invasion of Ukraine in 2022.


These allocations are strategic, or long-term in nature. They do not show additional capital that may be deployed according to shorter-term China views, such as the view that the passive flows into CGBs could be supportive for both the bonds and the currency. Today, the passive flows opportunity in the FTSE World Government Bond Index is still yet to unfold fully, with an estimated $130bn of flows expected by late 20248.


The inclusion of CGBs in major bond indices underscore China’s importance on the global economic stage. Are your portfolios ready for this update?

About the Authors

Julia Rees, CFA

Head of Portfolio Strategy, Strategic Advisory Solutions

Julia Rees, CFA

Romain Duvergé

Senior Market and Portfolio Strategist, Strategic Advisory Solutions

Romain Duvergé

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1 Source: Goldman Sachs Asset management. As of December 2020. See more explanations on the methodology below the table in the section How Risky is it to Ignore China Bonds in a Global Aggregate Bond Portfolio?

2 Source: The figures published here are estimated and unaudited as of December 2020, and are subject to potentially significant revisions over time.  Actual tracking error may vary significantly from the information presented above.

3 Source: Haver, IMF and GSAM. GDP data are PPP measures (current international dollars). Data as of March 29, 2022, using IMF WEO figures from October 2021 projections. All developed nations as categorised by the IMF.

4 Source: IMF and Goldman Sachs Asset Management. Percentage changes are in real GDP. Data as of December 31, 2021.

5 Source: Goldman Sachs Asset Management. As of March 30, 2022. Assuming China equities represent 1/3 of the MSCI Emerging market equities index.

Source: Bloomberg and Goldman Sachs Asset Management. Correlations on weekly returns for the last 5 years (Dec-2016 to Dec 2021), as of December 31, 2021.

Source: Bloomberg and Goldman Sachs Asset Management. As of March 30, 2022.

Source: FTSE and GSAM. As of March 30, 2022.




Correlation is a statistic that measures the degree to which two variables move in relation to each other which has a value that must fall between -1.0 and +1.0.

The Bloomberg Global Aggregate Bond Index measures global investment grade debt from 24 local currency markets, including treasury, government related, corporate, and securitized fixed rated bonds from both developed and merging market issuers.

The FTSE World Government Bond Index (FTSE WGBI)  measures exposure to the global sovereign fixed income market, the index measures the performance of fixed-rate, local currency, investment-grade sovereign bonds.

The JPMorgan GBI-EM Index is an unmanaged index tracking foreign currency denominated debt instruments of emerging markets.

The FTSE Goldman Sachs China Government Bond Index measures the performance of Chinese Yuan-denominated, fixed-rate government bonds issued in mainland China. Any bonds with maturity greater than 30 years from issuance are excluded from the index.

Risk Considerations
All investing involves risk.

Bonds are subject to interest rate, price and credit risks. Prices tend to be inversely affected by changes in interest rates.

Investments in foreign securities entail special risks such as currency, political, economic, and market risks. These risks are heightened in emerging markets. Emerging markets securities may be less liquid and more volatile and are subject to a number of additional risks, including but not limited to currency fluctuations and political instability.

The currency market affords investors a substantial degree of leverage. This leverage presents the potential for substantial profits but also entails a high degree of risk including the risk that losses may be similarly substantial. Such transactions are considered suitable only for investors who are experienced in transactions of that kind.  Currency fluctuations will also affect the value of an investment.

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This information discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice. This material has been prepared by Goldman Sachs Asset Management and is not financial research nor a product of Goldman Sachs Global Investment Research (GIR). It was not prepared in compliance with applicable provisions of law designed to promote the independence of financial analysis and is not subject to a prohibition on trading following the distribution of financial research. The views and opinions expressed may differ from those of Goldman Sachs Global Investment Research or other departments or divisions of Goldman Sachs and its affiliates. Investors are urged to consult with their financial advisors before buying or selling any securities. This information may not be current and Goldman Sachs Asset Management has no obligation to provide any updates or changes.

Tracking Error (TE) is one possible measurement of the dispersion of a portfolio’s returns from its stated benchmark. More specifically, it is the standard deviation of such excess returns. TE figures are representations of statistical expectations falling within “normal” distributions of return patterns. Normal statistical distributions of returns suggests that approximately two thirds of the time the annual gross returns of the accounts will lie in a range equal to the benchmark return plus or minus the TE if the market behaves in a manner suggested by historical returns. Targeted TE therefore applies statistical probabilities (and the language of uncertainty) and so cannot be predictive of actual results. In addition, past tracking error is not indicative of future TE and there can be no assurance that the TE actually reflected in your accounts will be at levels either specified in the investment objectives or suggested by our forecasts.

Economic and market forecasts presented herein reflect a series of assumptions and judgments as of the date of this presentation and are subject to change without notice. These forecasts do not take into account the specific investment objectives, restrictions, tax and financial situation or other needs of any specific client. Actual data will vary and may not be reflected here. These forecasts are subject to high levels of uncertainty that may affect actual performance. Accordingly, these forecasts should be viewed as merely representative of a broad range of possible outcomes. These forecasts are estimated, based on assumptions, and are subject to significant revision and may change materially as economic and market conditions change. Goldman Sachs has no obligation to provide updates or changes to these forecasts. Case studies and examples are for illustrative purposes only.

Index Benchmarks
Indices are unmanaged. The figures for the index reflect the reinvestment of all income or dividends, as applicable, but do not reflect the deduction of any fees or expenses which would reduce returns. Investors cannot invest directly in indices. The indices referenced herein have been selected because they are well known, easily recognized by investors, and reflect those indices that the Investment Manager believes, in part based on industry practice, provide a suitable benchmark against which to evaluate the investment or broader market described herein.

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