English Portfolio Management

What access to Chinese bonds?

Exposure to the renminbi and the Chinese economy is to be desired (this century will be dominated economically by Asia/China and exposure to Asia/China is necessary), so the crucial question remains: what is the best way to achieve this.

Bonds and cash in the three major reserve currencies (dollar, euro and yen) have a poor outlook (especially the dollar, which is expected to have yields that are significantly negative relative to inflation). China’s onshore bond markets, on the other hand, offer nominal yields around 3% for medium to long maturities. Moreover, expectations are positive for the renminbi and Chinese bonds should become more important in the future as the dominance of the US unravels and the dollar as a reserve currency becomes more uncertain.

Investing in bonds means receiving interest and exposure to a currency against the risk of volatility and default. In the Chinese case, the lack of transparency leads to possible concentrations in risky borrowers; real estate risks in particular seem very important given the number of projects heavily financed with debt. There is therefore an asymmetric proposition: the downside risk is material and the chances of appreciation limited if we exclude currency appreciation. Exchange controls, the legal and political system, and the absence of rule of law are other risks to be considered. Some of these risks can be greatly reduced by diversifying into ETFs or avoiding private issuers (remember that the Chinese government has a strong balance of payments and large dollar reserves), but it is difficult to navigate.

Institutional investors are already betting on these local bonds in Chinese currency. However, what about the international individual investor? Exposure to the renminbi and the Chinese economy is to be desired (this century will be dominated economically by Asia/China and exposure to Asia/China is necessary), so the crucial question remains: what is the best way to achieve this.

After some research, we find that most emerging market bond indices include little or no local currency Chinese bonds (and generally only since the beginning of 2019), for about 10%. If you go with a broader emerging market bond ETF, keep in mind that the high yield is often due to weakness in other currencies (as we’ve seen in recent years with the Turkish lira).  Then the 2 best ETFs on Chinese bonds proposed by the database have an expense ratio of 0.50% for VanEck Vectors ChinaAMC China Bond ETF (which tracks the ChinaBond China High Quality Bond Index, composed of renminbi-denominated fixed-rate bonds) and 0.7% for the KCCB KraneShares China Corporate High Yield Bond USD Index ETF. The latter tracks outstanding high-yield debt denominated in U.S. Dollars and issued by Chinese companies. With AuMs of only a few million, I can’t even imagine the impact on the ETF’s price if a large position is purchased! Finally, the Blackrock China Bond Fund aims to maximize total return and invests 70% of its total assets in fixed income securities denominated in Renminbi or other non-Chinese domestic currencies. Moreover, the management fee is prohibitive at 0.75%. Otherwise, with an expense ratio of 0.25%, the CSOP CYC/CYB (ISIN: SGXC34971074) and accessible on the Singapore Exchange, can replicate the returns of the “ChinaBond ICBC 1-10 Year Treasury and Policy Bank Bond” index. With an expense ratio of 0.3% the NikkoAM ZHD/ZHS invests 99.49% in Chinese government bonds CHINA GOVERNMENT BOND, but on different maturities. The latter two therefore have fees that are more reasonable, a local currency exposure and no private constituents.

CSOP seems to be a recognized asset manager, the custodian is a subsidiary of HSBC in Singapore and the local stock exchange and regulator have a good reputation for governance. The expected return is just under 3% with an expense ratio of 25 bps and the purchase fees for ETFs/shares are a minimum of 2-2.5 USD per order with a good broker. According to my preliminary research, the reduced 7% rate on Chinese bond interest applies in view of the Sino-Singapore treaty and there is in principle no withholding tax on ETF distributions to non-resident investors.

In conclusion:

  • For a standard investor, an investment (despite the exposure to RMB and the lower correlation at portfolio level) is certainly not worth it and it is better to keep it simple by focusing on a standard investment plan with 2-3 well diversified equity ETFs.
  • For those who manage larger portfolios, with more sophistication to reduce exposure and correlation to equities, a small allocation in an ETF like CSOP’s allows for a return above 2% coupled with a currency exposure that will become important. I personally stay out of emerging bonds (unexpected currency movements often dented returns) but given the expected appreciation of the renminbi, I might be tempted to put a little toe in CSOP (goal: increase RMB exposure and reduce equity correlation). I will post an update as soon as I have more experience with ETFs listed on the Singapore exchange which could be a good opening to Asia (but a no-go for US, Swiss and European assets). For the core of my portfolio, I prefer to have exposure to renminbi through equities, but that is another chapter…