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April 08, 2021 | GSAM Connect

China Government Bond Market – Too Big to Ignore

Last week FTSE Russell affirmed that China will be included in the FTSE World Government Bond Index from October 2021, confirming China’s membership of three major global bond indexes (Exhibit 1 and 7). Below we recap the investment case for an allocation to China government bonds1 and detail why now is an opportune time to gain access.

Exhibit 1: China will be a member of three major global bond indices this year

Source: GSAM, Goldman Sachs Global Investment Research, Barclays, FTSE Russell. Estimated Barclays Figures. As of March 2021. For illustrative purposes only.

The Investment Case

  • Attractive Yields. China government bonds provide an attractive yield premium over comparable maturity developed market (DM) bond yields, even after accounting for the recent rise in global rates (Exhibit 2). In addition, China government bond yields exhibit lower volatility than similarly rated sovereign bond markets. Year-to-date, 10-year China government bonds have experienced a 17bps rise. This compares with a 74bps and 56bps rise in comparable maturity US and UK sovereign bond yields, respectively2.
  • Potential Diversification Benefits. From a portfolio perspective, China government bonds present attractive diversification benefits due to their low correlation with other major bond markets (Exhibit 3), as well as major global bond indexes alongside US and Chinese equities (Exhibit 4). 

Exhibit 2: China bonds offer attractive yields relative to DM rates

Source: Macrobond, GSAM. As of March 26, 2021.

Exhibit 3: China government bonds exhibit low correlations with other bond markets... Exhibit 4: ...And Other global bond indexes and Chinese equities.

Source: GSAM, Bloomberg. As of January 29, 2021. Correlations based on weekly returns for the last 5 years. Government bond correlation: 10 -year government bonds Past correlations are not indicative of future correlations, which may vary. Past performance does not guarantee future results, which may vary. For illustrative purposes only. Indexes used: FTSE China Government Bond Index, Bloomberg Barclays Global Aggregate (Hedged), Bloomberg Barclays Global Aggregate Corporate (Hedged), Bloomberg Barclays US Corporate High Yield, JP Morgan GBI-EM Global Diversified Composite, Bloomberg Barclays US Treasury Index, MSCI China A Onshore Index, S&P 500 Index. Diversification does not protect an investor from market risk and does not ensure a profit. 

Why Now?

  • Too Big to Ignore. China is home to the world’s second largest onshore bond market and the third largest sovereign bond market, making it simply too big to ignore. In fact, its sovereign bond market is larger than that of Germany, France and Spain combined.
  • Improved Access Due to Financial Market Liberalization. A raft of financial market reforms has helped improve secondary market liquidity in Chinese government bond markets, as reflected by increased trading transaction volume in recent years (Exhibit 5). There has also been a widening in the scope of hedging instruments that are available to foreign investors, though these vary depending on the channel through which investors access the China domestic bond market (Exhibit 6).
  • Tailwind of Investor Inflows. Policymakers have taken a series of steps to open China’s bond markets to foreign investors (Exhibit 7). Nonetheless, foreign investor ownership of Chinese government debt amounts to just 10%3. This is modest relative to China’s economic standing and is around one third of the 29% foreign investor presence in the US Treasury market4. We think index inclusion, continued improvements in market functioning and liquidity, and the broadened availability of hedging tools will see continued investor inflows—both from passive and active investors—in the coming years. Alignment of foreign reserve holdings with China’s weight in the International Monetary Fund (IMF) Special Drawing Rights (SDR) are an added impetus for potential inflows into China’s government bond market.

Exhibit 5: Rising trading volumes reflect improved market liquidity

Source: Macrobond, ChinaBond.

Exhibit 6: Instruments and hedging tools accessible to foreign investors

*Other investors include all mid/long-term overseas investors approved by PBOC, including commercial banks, insurance, securities companies, asset managers, pension funds, charity funds, endowment funds, trust companies, or investment products issued by the aforementioned institutions, etc. Source: Goldman Sachs Global Investment Research. PBOC, SAFE, CSRC

Exhibit 7: China has taken a series of steps to open its bond market to foreign investors

Source: GSAM. China Foreign Exchange Traded System. As of March 2021.

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