China bonds take on more global role

Global appetite for China bonds continues to grow, despite the uncertain investment environment. Encouraged by the inclusion of these assets in global indices, investors have increasingly taken advantage of this ever-wider window of opportunity to access the potential of the domestic growth story.

For example, international holdings accounted for a total of RMB3.96 trillion ($590 billion) of onshore China bonds, representing 2.9% of the total amount of outstanding onshore China bonds compared with just 1.3% 10 years ago.

It is notable to have witnessed the leadership role of ETFs amid this trend, while global fixed income ETFs have reached $1.6 trillion in assets.

To understand the main developments and outlook for the China bond market, along with opportunities in Hong Kong-listed China fixed income ETFs, AsianInvestor and HKEX brought together several market specialists at a recent webinar:

• Hui Sien Koay, Lead Index Fixed Income Strategist, Asia ex-Japan, BlackRock
• Laura Lui, Partner & Co-Chief Investment Officer, Premia Partners
• Vincent Au, Managing Director, Chief Investment Officer, ALPS Advisory
• Brian Roberts, Managing Director, Head of Exchange Traded Products, HKEX
• Rebecca Sin, ETF Analyst, Bloomberg (moderator)

There is certainly scope for greater allocation to China bonds among foreign investors. According to a poll of the webinar audience, for instance, almost 30% are yet to have exposure to these assets, and for one-third, their allocation is relatively low, between 1% and 6%.

ETFs also stand to gain as access to the China bond market grows. Around 28% of the audience polled currently use ETFs, compared with mutual funds and direct platforms such as QFII/RQFII, Bond Connect and the China Interbank Bond Market.

The scope for growth via ETFs aligns well with plans at HKEX to further improve the efficiency of the Hong Kong market. According to Roberts, measures in the pipeline include reducing trading spreads, increasing the supply of liquidity and improving the creation/redemption process. In turn, these will improve efficiency for ETF issuers and market makers and the experience for investors when trading ETFs on HKEX.

Read more takeaways below and watch the on-demand version here

KEY INSIGHTS

Investing in China: shaping the outlook for fixed income and ETFs

Vincent Au
“Some commentators suggest that China is not ‘investable’ at the moment, but I remain optimistic about the outlook for the market. The main challenges relate to short-term policy choices by the government rather than structural or fundamental issues. A key factor for China bond sentiment is the negative outlook for the property market, yet demand is not an issue. Valuations also look more attractive than previously.”

Hui Sien Koay
“Over the past two years, we’ve seen rapid growth in terms of inflows into China bonds due to inclusion in global indices. In 2019, when China started to become a main player in global index building blocks, the natural weight was 5%. Fast-forward to today, this has grown to 8%, mostly due to a strong RMB and stable yields.”

Laura Lui
“Index inclusion has driven positive developments for ETF investors who are focused on the total cost of ownership. In Hong Kong, HKEX introduced incentives in 2021 to support the development of fixed income ETFs, such as fee waivers on trading tariffs. In addition, there is no withholding tax. All this makes it quicker for investors to break even when holding China fixed income ETFs.”

Selecting and trading China bond ETFs

Brian Roberts
“The appetite for ETFs is based on them providing an efficient way to access the China bond market, encouraging institutional investors across Asia Pacific that are starting to enter this market to use ETFs. Diversification and low costs are other features of China bond ETFs that make these harder-to-reach underlying appealing to investors.”

Hui Sien Koay
“When selecting China bond ETFs, it requires the same approach as when buying any bond, although there are additional underlying market nuances with China. Exposure, total costs of ownership and performance are three key aspects for investors to consider. For example, how precise is the market exposure? What are the total costs, including both fees and execution costs, with trading strategies? And how can you find the right performance? They are useful instruments given they can trade like stocks through exchanges or like bonds over-the-counter.”

Rebecca Sin
“Investors often forget to look at total cost of ownership. Some of them might say they would rather trade a US-listed China bond ETF rather than one listed in Hong Kong. However, for Asian-based investors who take into account trading spreads, liquidity, management fees and withholding tax, it can typically be more advantageous to trade Hong Kong-listed products rather than those listed elsewhere.”

Laura Lui
“We tell our clients to trade ETFs in the same time zone because market-makers can quote ETFs even when market conditions are more volatile.”

Vincent Au
“From a top-down perspective, we look at the investment strategy of the ETF and how it fits into our overall portfolio, either in terms of strategic or tactical asset allocation. We then look at the investment methodology and features of the ETF. Looking bottom up, liquidity is clearly an important factor, as are the bid-offer spreads, trading volumes, fees and trading errors.”

Brian Roberts
“Just because a lot of China bond ETFs are thinly traded on the screen, it doesn’t mean they are illiquid – just that it doesn’t trade a lot. Market makers can help facilitate that liquidity.”

A bright future for China bond ETFs

Hui Sien Koay
“ETFs are leading the way in terms of penetration of China bonds by foreign investors, and the growth in tools and exposure available across currencies, duration and rates will give investors a lot more opportunity.”

Laura Lui
“The China bond market is too big to ignore. It is not a question of if to get in, but when.”
 

Taxation as a significant part of total cost of ownership (TCO) is less apparent and thus shunned by investors. Visit ETF Tax Calculator jointly developed by HKEX and EY to help quantify the impact of withholding tax and minimise TCO for China bond ETF investment.