- The inclusion of Chinese local currency bonds in the Bloomberg Barclays Global Aggregate Bond Index will include representation in the global fixed income market.
- Foreign ownership of Chinese bonds is likely to increase, which will support the renminbi but will also subject China’s bond market to greater external discipline.
- We believe that Chinese bonds are currently undervalued as collateral in the Chinese capital market system and therefore represent a good buying opportunity.
The forthcoming inclusion of Chinese local currency bonds in the Bloomberg Barclays Global Aggregate Bond Index (Global Aggregate Index) will significantly open up China’s bond market, bringing greater diversity and representation to the global fixed income universe. It will also mark an important stage in China’s progress toward more open and transparent capital markets. For investors, this will provide an opportunity to invest in a vast and important bond market that has until now been very difficult to access.
Chinese RMB‑denominated government and policy bank bonds will be phased into the Global Aggregate Index over a 20‑month period beginning in April, and the weight will ultimately increase gradually to around 6% of the index. In total, more than 300 issues denominated in Chinese renminbi will enter the index universe. The move follows extensive work from the Chinese government and the People’s Bank of China to enhance and strengthen the country’s bond market. In the past, China’s determination to remain in control of its currency and to supervise the flow of capital into the country has meant that its bond market has not operated as efficiently and transparently as those of most developed market countries. As such, foreign ownership of China’s onshore market has been very low—around 3% versus an average of more than 25% across developed country markets.
(Fig. 1) Estimated Weight by Currency of Denomination with China Inclusion
Bloomberg Barclays Global Aggregate Bond Index
Source: Bloomberg Barclays. Bloomberg Index Services Ltd. Copyright © 2019, Bloomberg Index Services Ltd. Used with permission.
Foreign Ownership Is A Carrot—And A Stick
To qualify for inclusion in the Global Aggregate Index, China has implemented a number of measures to improve access to its fixed income market via its Bond Connect program through which foreign investors can invest in Chinese bonds through investment links between Hong Kong and the mainland. Specific enhancements to the program have included the implementation of a new delivery versus payment settlement system for transactions and the ability to allocate block trades across portfolios.
The inclusion of Chinese bonds in the Global Aggregate Index will significantly increase foreign ownership of those bonds, which means the authorities will be forced to hand over a certain amount of control of its capital markets to overseas investors. Active bond investors will be able to sell Chinese bonds if they have a negative view on China, and even short them if there is a functioning futures market. As such, the inclusion of Chinese bonds in the Global Aggregate Index functions as both a carrot and a stick for the Chinese government: the carrot is that China will be able to attract capital, which will underpin the currency and diversify against the risk of domestic outflows; the stick is that if the foreign investors disagree with the path of monetary policy followed by the People’s Bank of China (PBoC), they will be able to quickly disengage from the Chinese bond market.
A last point to note is that the decision by Bloomberg to include China in its flagship aggregate index is likely to be followed by other fixed income benchmark providers. We estimate that the inclusion of China by FTSE would potentially represent a weight of 5% in its World Government Bond Index (WGBI), while J.P. Morgan is likely to include China in its Global Bond Index Emerging Market Global Diversified with a weight of 10%.
An Enhanced Opportunity Set
The presence of Chinese bonds in the Global Aggregate Index is likely to have an immediate impact on its risk and return profile. If Chinese bonds were included now, for example, the result for the index would be a slightly shorter duration profile and a marginally higher yield compared with current levels—both positive developments from a bond investor’s point of view. From a cyclical perspective, we expect Chinese onshore rates to perform given that the PBoC is currently embarking on an easing cycle. Ultimately, renminbi‑denominated Chinese bonds are likely to act as a strong diversifier in global portfolios if China’s policy cycle diverges from the U.S. and EU.
Overall, we believe that Chinese bonds are currently undervalued as collateral in the Chinese capital market system—in other words, they have the potential to perform better than other Chinese assets over time. As a result, T. Rowe Price is already invested in local Chinese government bonds, ahead of their inclusion in the index, across our mandates and investment vehicles, including our range of mutual funds and SICAVs (Société d’investissement à capital variable)—open-ended collective investment funds. As things stand, our inclination is to adopt a longer position than the opening weight of Chinese bonds in the index as we believe that there will be significant demand for the bonds from investors looking for diversification. At present, the 10‑year yield is 3.1% and inflation is under control, so Chinese bonds look reasonably attractive.
The Importance Of Local Knowledge
At T. Rowe Price, we have the capability to invest in onshore (CNY) as well as offshore (CNH) currency markets in addition to markets in Hong Kong. Our office in Hong Kong gives us a local presence, enabling our team of research analysts and traders to gain on‑the‑ground insights into this evolving and increasingly prominent market. From an implementation and trading perspective, of the prevailing investment programs, we have favored Bond Connect as our preferred mechanism as its setup procedures are less onerous than others available.
Trading Chinese bonds is likely to be focused on China government bonds and on core policy bank bonds, which are included in the broadened Global Aggregate Index. From a credit viewpoint, we are likely to put more emphasis on issuers that provide robust disclosures and already issue overseas. We are likely to avoid most onshore credit bonds and Local Government Funding Agency bonds for the time being as transparency can sometimes be lacking and reporting standards can be less comprehensive.
Overall, we believe that the inclusion of Chinese locally denominated bonds in the Global Aggregate Index is a positive evolution for fixed income investors and that T. Rowe Price is well prepared for this transition given our dedicated research and trading resources in Hong Kong.
T. ROWE PRICE BEYOND THE NUMBERS
We were “early adopters” of Chinese bonds, and this has given us a wealth of insight into China’s fixed income market. For many years, our Hong Kong‑based research team of credit analysts and our dedicated sovereign research team have been conducting fundamental research for a number of years on China. Our local trading presence allows us to pursue best execution in situ and to take advantage of differences in regional market liquidity as well as helps us to maintain a global trading capability.
WHAT WE’RE WATCHING NEXT
The initial 6.1% weighting is material, but it does not reflect China’s true weight in terms of capitalization. Whether—and when—China’s weighting increases will depend on how accessible, reliable, and transparent its debt market proves to be. Geopolitics—specifically China’s trading relationship with the U.S.—will also be a factor.
This material is being furnished for general informational purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, and prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.
The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.
Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date written and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.
The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. It is not intended for distribution to retail investors in any jurisdiction.
Australia—Issued in Australia by T. Rowe Price Australia Limited (ABN: 13 620 668 895 and AFSL: 503741), Level 50, Governor Phillip Tower, 1 Farrer Place, Suite 50B, Sydney, NSW 2000, Australia. For Wholesale Clients only.
Brunei—This material can only be delivered to certain specific institutional investors for informational purpose upon request only. The strategy and/or any products associated with the strategy has not been authorised for distribution in Brunei. No distribution of this material to any member of the public in Brunei is permitted.
Canada—Issued in Canada by T. Rowe Price (Canada), Inc. T. Rowe Price (Canada), Inc.’s investment management services are only available to Accredited Investors as defined under National Instrument 45-106. T. Rowe Price (Canada), Inc. enters into written delegation agreements with affiliates to provide investment management services.
China—This material is provided to specific qualified domestic institutional investor or sovereign wealth fund on a one-on-one basis. No invitation to offer, or offer for, or sale of, the shares will be made in the People’s Republic of China (“PRC”) (which, for such purpose, does not include the Hong Kong or Macau Special Administrative Regions or Taiwan) or by any means that would be deemed public under the laws of the PRC. The information relating to the strategy contained in this material has not been submitted to or approved by the China Securities Regulatory Commission or any other relevant governmental authority in the PRC. The strategy and/or any product associated with the strategy may only be offered or sold to investors in the PRC that are expressly authorized under the laws and regulations of the PRC to buy and sell securities denominated in a currency other than the Renminbi (or RMB), which is the official currency of the PRC. Potential investors who are resident in the PRC are responsible for obtaining the required approvals from all relevant government authorities in the PRC, including, but not limited to, the State Administration of Foreign Exchange, before purchasing the shares. This document further does not constitute any securities or investment advice to citizens of the PRC, or nationals with permanent residence in the PRC, or to any corporation, partnership, or other entity incorporated or established in the PRC.
DIFC—Issued in the Dubai International Financial Centre by T. Rowe Price International Ltd. This material is communicated on behalf of T. Rowe Price International Ltd. by its representative office which is regulated by the Dubai Financial Services Authority. For Professional Clients only.
Before 1 March 2019: EEA—Issued in the European Economic Area by T. Rowe Price International Ltd, 60 Queen Victoria Street, London EC4N 4TZ which is authorised and regulated by the UK Financial Conduct Authority. For Professional Clients only.
From 1 March 2019: EEA ex-UK—Unless indicated otherwise this material is issued and approved by T. Rowe Price (Luxembourg) Management S.à r.l. 35 Boulevard du Prince Henri L-1724 Luxembourg which is authorised and regulated by the Luxembourg Commission de Surveillance du Secteur Financier. For Professional Clients only.
From 1 March 2019: UK—This material is issued and approved by T. Rowe Price International Ltd, 60 Queen Victoria Street, London, EC4N 4TZ which is authorised and regulated by the UK Financial Conduct Authority. For Professional Clients only.
Hong Kong—Issued in Hong Kong by T. Rowe Price Hong Kong Limited, 21/F, Jardine House, 1 Connaught Place, Central, Hong Kong. T. Rowe Price Hong Kong Limited is licensed and regulated by the Securities & Futures Commission. For Professional Investors only.
Korea—This material is intended only to Qualified Professional Investors upon specific and unsolicited request and may not be reproduced in whole or in part nor can they be transmitted to any other person in the Republic of Korea.
Malaysia—This material can only be delivered to specific institutional investor upon specific and unsolicited request. The strategy and/or any products associated with the strategy has not been authorised for distribution in Malaysia. This material is solely for institutional use and for informational purposes only. This material does not provide investment advice or an offering to make, or an inducement or attempted inducement of any person to enter into or to offer to enter into, an agreement for or with a view to acquiring, disposing of, subscribing for or underwriting securities. Nothing in this material shall be considered a making available of, solicitation to buy, an offering for subscription or purchase or an invitation to subscribe for or purchase any securities, or any other product or service, to any person in any jurisdiction where such offer, solicitation, purchase or sale would be unlawful under the laws of Malaysia.
New Zealand—Issued in New Zealand by T. Rowe Price Australia Limited (ABN: 13 620 668 895 and AFSL: 503741), Level 50, Governor Phillip Tower, 1 Farrer Place, Suite 50B, Sydney, NSW 2000, Australia. No Interests are offered to the public. Accordingly, the Interests may not, directly or indirectly, be offered, sold or delivered in New Zealand, nor may any offering document or advertisement in relation to any offer of the Interests be distributed in New Zealand, other than in circumstances where there is no contravention of the Financial Markets Conduct Act 2013.
Philippines—THE STRATEGY AND/ OR ANY SECURITIES ASSOCIATED WITH THE STRATEGY BEING OFFERED OR SOLD HEREIN HAVE NOT BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE COMMISSION UNDER THE SECURITIES REGULATION CODE. ANY FUTURE OFFER OR SALE OF THE STRATEGY AND/ OR ANY SECURITIES IS SUBJECT TO REGISTRATION REQUIREMENTS UNDER THE CODE, UNLESS SUCH OFFER OR SALE QUALIFIES AS AN EXEMPT TRANSACTION.
Singapore—Issued in Singapore by T. Rowe Price Singapore Private Ltd., No. 501 Orchard Rd, #10-02 Wheelock Place, Singapore 238880. T. Rowe Price Singapore Private Ltd. is licensed and regulated by the Monetary Authority of Singapore. For Institutional and Accredited Investors only.
Switzerland—Issued in Switzerland by T. Rowe Price (Switzerland) GmbH, Talstrasse 65, 6th Floor, 8001 Zurich, Switzerland. For Qualified Investors only.
Taiwan—This does not provide investment advice or recommendations. Nothing in this material shall be considered a solicitation to buy, or an offer to sell, a security, or any other product or service, to any person in the Republic of China.
Thailand—This material has not been and will not be filed with or approved by the Securities Exchange Commission of Thailand or any other regulatory authority in Thailand. The material is provided solely to “institutional investors” as defined under relevant Thai laws and regulations. No distribution of this material to any member of the public in Thailand is permitted. Nothing in this material shall be considered a provision of service, or a solicitation to buy, or an offer to sell, a security, or any other product or service, to any person where such provision, offer, solicitation, purchase or sale would be unlawful under relevant Thai laws and regulations.
USA—Issued in the USA by T. Rowe Price Associates, Inc., 100 East Pratt Street, Baltimore, MD, 21202, which is regulated by the U.S. Securities and Exchange Commission. For Institutional Investors only.
© 2019 T. Rowe Price. All rights reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the Bighorn Sheep design are, collectively and/or apart, trademarks of T. Rowe Price Group, Inc.