Chinese bonds have defied the general negative trend in bond and credit markets this year until recently, but ended May with heavy losses.
Three Chinese bond markets
The universe of Chinese fixed income securities essentially consists of three markets. One is the renminbi denominated onshore and offshore markets and the other is hard currency denominated bonds. The onshore renminbi (RMB) market is by far the largest and consists of fixed income securities issued in China by companies and governments. Foreign investors have been able to invest in onshore RMB bonds through the Bond Connect Scheme since 2016. Hard currency bonds are smaller but an important market for investors active in Asian high yield bonds. Offshore bonds, also sometimes called «dim sum» bonds, are mainly traded in Hong Kong. Although the Chinese bond market is now the second largest in the world, most of China’s debt is created through bank loans.
PBoC is not focused on inflation
While the Federal Reserve continues to tighten monetary reins, the People’s Bank of China (PBoC) does not need to raise interest rates. In doing so, China is the only major economy that can swim against the tide because inflation is not as high in the country. For example, the Economist Intelligence Unit forecasts that CPI will be 2.2 percent this year compared with 7.7 percent in the US.
Some investors may have anticipated this, as Morningstar data shows European investors invested a net €4.5 billion in Chinese bond funds over the 2020-2021 period. Over that period, the category grew from less than EUR 1 billion to EUR 7.1 billion at the end of last year. Investors have also been attracted to the diversification benefits. According to JPMorgan Asset Management, the correlation between Chinese and global government bonds has averaged 0.27 over the past 15 years.
However, interest has waned somewhat in recent months and European investors have pulled nearly EUR 1.1 billion from Chinese bond funds this year. US nominal yields now exceed those of China’s riskier government bonds for the first time in 12 years. However, real yields in China remain well above those of the US and are still positive.
Relatively strong year-to-date performance
The index Morningstar uses to evaluate funds within the China bond category is the Markit iBoxx ALBI China Offshore index, which (after a 1.4 percent loss last month) posted a year-to-date return of 1.7 percent in euro terms at the end of May 2022. This is in stark contrast to JPMorgan’s GBI-EM Global Diversified index, a leading benchmark for emerging market bonds, which has lost 5 percent so far this year. The Bloomberg Global Aggregate Bond index lost 5.6 percent over the same period.
Top 5
For this week’s Top 5, we look at mutual funds in the Morningstar China Bond category that have a distribution-free share class available in the Netherlands. These five funds have shown the best performance based on their returns over the first four months of 2022.
In first place is the HSBC GIF RMB Fixed Income fund which aims to achieve long-term capital growth and income by investing in a portfolio of onshore or offshore issued Chinese renminbi bonds. The fund can invest in investment grade bonds, but high yield or non-credit rated bonds issued by the government, government related entities and companies are also eligible. As at end-April 2022, the fund had an allocation of 40 percent to banks and over 20 percent in government bonds followed by some 14 percent exposure to the real estate sector. The fund has been managed by Alfred Lap Chung Mui, the head of Asian Credit in the Asian Fixed Income team at HSBC Asset Management in Hong Kong, since July 2014. Since September 2019, he has been supported by Ming Leap.
Also in the top 5, we find the BGF China Bond fund which receives a Neutral rating from Morningstar analysts for the retail fund class available in the Netherlands/Belgium. The fund is managed by Eric Liu and until recently Artur Piasecki, who left BlackRock at the end of March and stepped down as co-manager of this fund. Piasecki was one of the most experienced Asian high-yield investors on the team, and while his departure is a loss, Morningstar retains confidence in Eric Liu and the broad analyst team. Liu has 16 years of investment experience and joined BlackRock in 2016 as a China specialist. He is joined by co-managers Suanjin Tan and Yii Hui Wong.
This strategy combines top-down allocation decisions between China’s onshore and offshore bond markets with bottom-up credit research. However, rapid asset growth over a short period of time has led to capacity issues that have negatively affected the strategy’s agility. The strategy’s asset size exploded from USD 300 million to USD 8 billion between December 2019 and December 2021, mainly due to heavy inflows. Prior to 2017, the strategy was heavily invested in the offshore «dim sum» bond market, but in the meantime that exposure has decreased significantly due to the growth of the Chinese onshore bond market. At the end of April 2022, the portfolio held about 57 percent in onshore Chinese bonds, 42 percent in offshore bonds and 1 percent in cash.
Top 5 Chinese bond funds, as per asset class for the Netherlands:
Top 5 Chinese bond funds, as per asset class for Belgium:
Thomas De fauw is a manager research analyst at Morningstar. Morningstar analyses and evaluates investment funds based on quantitative and qualitative research. Morningstar is one of Investment Officer’s knowledge partners and ranks five investment funds or providers each week.
Related articles on Investment Officer Luxembourg: