Central banks’ quantitative easing has driven a 36% average y-o-y increase in negative yielding debt over the past five years to reach USD 11 trillion at the end of March 2020. This new world is considerably more volatile - and correlated - than before, UBS Asset Management experts say in their latest report ‘China Fixed Income – Investing in a new world.’
Global economic uncertainty has pushed annualised volatility of some developed country bonds to double-digit levels. Given the challenges of negative yields and rising volatility, there’s a strong investment case for China onshore fixed income - particularly in the government and policy bank sectors. because of the following five key factors:
- Attractive yields: China bonds offer superior yields against most global government bond benchmarks, and we expect this to continue to be the case given the differences in China’s monetary policy regime;
- Low volatility: China’s bond markets have been markedly less volatile than global markets: largely because the domestic market is dominated by domestic investors and the banking sector holds a large part of the bond market – two factors which are unlikely to change in the near-term;
- Low correlation: offering diversification benefits against global asset benchmarks. China’s economy and policy cycles are not directly influenced by Fed policies or volatility in the US banking sector volatility, as in other western economies. After USD global currency status ascended since the 50’s, so did its influence over other western financial markets. China’s capital markets have largely been immune to US policy action as they’re self-funded as one of the largest creditor nations in the world. Their domestic capital market has low foreign ownership, so correlation vs. global markets is also low, and will likely remain so;
- Safe haven properties: China government bonds have performed well during periods of volatility, which suggest they have potential to serve as a safe haven asset for global investors;
- Historically low hedging costs: the cost of hedging into CNY is at historical lows, so now might be a good time for investors to take advantage.
But for all of China’s progress, challenges still remain. Investors need to navigate the nuances of China’s corporate structures, linkages to the state and liquidity in credit markets. China’s rising status as one of the world’s largest economies, the rise of the RMB as a reserve currency, demographic change and the growth of China’s pension industry, will make positioning in China an essential part of global asset allocation strategy in the future.
Please find attached the full report ’China Fixed Income - Investing in a new world’ from UBS Asset Management.