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How Chinese bonds can enhance your portfolio

The Emerging View

16 March 2018

Despite the size of the Chinese onshore fixed income market, most investors are not involved. Chinese bonds have yet to enter the most commonly used global and Emerging Markets (EM) fixed income indices, and there are still technical obstacles, which impede trading. But change may be afoot. President Xi Jinping recently acquired significantly more domestic political capital, which will enable him to push forward, with renewed vigour, the Chinese economic reform agenda, including addressing the remaining obstacles to market access. We also expect index providers to eventually fully admit China into the benchmark indices, possibly within a relatively short period of time. Investors should rejoice at the prospect of greater access to Chinese fixed income. The report uses data from 2004 until February 2018 to demonstrate some extremely enviable characteristics of Chinese bonds. In our opinion, they are superior to US Treasury bonds in terms of their ‘safe haven’ characteristics and this important advantage will only grow over time in light of the growing twin-deficit challenges facing the US. Chinese bonds have lower volatility, yet attractive yields as well as low correlations with both US and EM local currency markets. This means that EM and developed market bond investors alike can benefit from allocating to onshore Chinese government bonds. One implication of greater access to Chinese bonds is that the ‘safe haven’ bid for US bonds and the Dollar may fall over time. This would be good for the world, because the Dollar would become far less volatile, which in turn would make EM local currency bonds more attractive to long-term institutional investors.

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