China: active opportunities
China’s fixed-income marketplace isn’t monolithic, but it is massive. The onshore RMB segment alone is bigger than those in France, Germany and the UK combined (see Exhibit 1).
Three different investable markets for Chinese bonds
Outside of Asia, “yuan” is generally the term used to describe China’s currency. But “renminbi” (abbreviation: RMB) is the official legal name of China’s currency, and the term used the most in China and in Asia overall. Bond investors should be aware of the two kinds of renminbi (see Exhibit 2) used in financial transactions.
- In “onshore” China (sometimes called mainland China), transactions are done using the onshore traded renminbi (abbreviation: CNY). This is where “onshore RMB”/“onshore CNY” bonds get their name.
- In “offshore” regions (those outside of mainland China), transactions are done using the offshore traded renminbi (abbreviation: CNH). This is where “offshore RMB”/“offshore CNH” bonds get their name.
China’s regulators are intent upon making the onshore RMB currency (the CNY) a more “internationalised” one – similar to how the US dollar (USD) is used around the world to conduct transactions. That makes the onshore RMB bond market increasingly important.
Key renminbi facts for fixed-income investors
The total value of China’s onshore RMB bond market reached USD 15.5 trillion at the end of 2020, and many market participants are expecting the market to grow significantly in the coming years (see Exhibit 3).
China’s onshore RMB bond market is also diverse, with three main segments of the market: money market instruments, “rates” and “credits”.
- Rates bonds form the largest segment of the onshore RMB market (55% as at 30 June 2020). This group broadly consists of central government bonds (CGBs), local government bonds (LGBs) and bonds from policy financial banks (PFBs, which are large financial institutions owned by the Chinese government).
- Credit bonds encompass issues from government-linked financing entities, state-owned enterprises (SOEs), financial institutions (such as banks and insurers) and privately owned (non-government) corporations. Credits make up about a quarter of the onshore RMB market.
- Money market instruments issued by banks and corporations make up the rest of the onshore RMB bond market.
Outstanding bonds by market
Source: Chinabond, Chinaclear, Wind, Standard Chartered Research. Data as at 30 June 2020.
When investing in the onshore RMB bond market, it’s important to work with a partner who can help you assess the creditworthiness of an issuer. The credit quality of bonds issued by LGBs, SOEs and private companies can vary widely. Moreover, China’s onshore credit rating system differs from international rating conventions. For example, onshore bonds rated AA+ would typically be rated as “high yield” on an international scale (see Exhibit 4).
Onshore RMB bonds’ breakdown by credit rating
Source: Wind, Standard Chartered Research. Data as at 30 June 2020.
China has been making it easier for non-mainland China investors to access to its domestic capital markets. This has paved the way for Chinese bonds to be included in global benchmark indices – with the latest being the FTSE Russell WGBI in November 2021. China is also working to make the renminbi a more “internationalised” currency. Together, these factors should help international investors’ holdings of RMB bonds to rise over time.
But international investors still own less than 3% (about USD 540 billion) of the entire RMB bond market (see Exhibit 5). This is significantly lower than the 10%-25% foreign bond ownership range observed in other emerging-market nations. It is also lower than China’s representation in major global bond indices. This indicates that foreign interest will likely keep growing in the coming years.
Foreign ownership of China bonds
Source: CEIC, WIND, Citi Research. Data as at 31 January 2021.
In recent years, governments and companies have grown increasingly comfortable using the renminbi to conduct international transactions (see Exhibit 6). This can help these institutions eliminate currency risk, since one currency doesn’t need to be exchanged for the other – a process that can cause fluctuations in value.
Another factor making the renminbi attractive to international investors is the way China’s central bank – the People’s Bank of China, or PBoC – has resumed using conventional tools (such as adjusting the short-term interest rate) to enact its monetary policy. Compare this with the unconventional tools that other large central banks are using, such as the massive bond purchases known as “quantitative easing”. Some investors consider these tools to be less sustainable and possibly riskier. That makes the PBoC’s more conventional approach – and China’s renminbi – more attractive to many international investors.
As the international community turns to the renminbi, there should be a corresponding need for investors to seek investment assets denominated in renminbi. This may help lift the value of RMB bonds over time, which would likely benefit investors who already own these bonds.
Global central bank reserves (as at 2Q 2020) and projected growth of RMB usage in global reserves by 2030
Source for global central bank reserves: IMF, JP Morgan Asset Management. Data as at 31 October 2019. Source for projected growth of RMB: Morgan Stanley Research, Haver.
Onshore RMB bonds have exhibited low correlations to other asset classes (see Exhibit 7). Case in point: onshore RMB bonds moved in the same direction as global bonds only 22% of the time. As a result, holding onshore RMB bonds in a global portfolio may improve overall diversification.
3-year return correlation of onshore RMB bonds vs other major asset classes
Source: Bloomberg. Data as at 31 December 2020.
Over time, the returns of onshore RMB bonds have been steady. Moreover, their volatility has remained low, meaning there have been relatively few large swings either up or down. When these two metrics are taken together, they can be expressed as a “risk/return” profile. And as Exhibit 8 shows, onshore RMB bonds have an attractive risk/return profile compared with other major asset classes. That can make onshore RMB bonds a helpful addition to a range of portfolios.
3-year risk/return profile (in USD)*
Source: Bloomberg, Allianz Global Investors. Data as at 31 March 2021. Please see the disclosure at the end of this document for important index information.
Interest rates in developed economies have been low or even negative for some time. This has contributed to low to negative yields for many types of bonds, as the accompanying chart shows. Moreover, given that the global economic environment continues to be somewhat weak, we expect interest rates to remain at the suppressed levels for some time. That makes it all the more important for investors to pursue sufficient sources of yield potential. Onshore RMB Chinese government bonds (CGBs) have a higher yield than most developed-market government bonds (see Exhibit 9). Moreover, CGBs offer an average credit rating of A+. That means investing in CGBs can provide investors with solid credit quality and attractive additional yields.
5-year government bond nominal yields
Source: Bloomberg, Markit IBoxx, JP Morgan, Allianz Global Investors. Data as at 31 December 2021. *Based on JP Morgan Asia Credit Index. Refers to yield-to-maturity (YTM). **Based on Markit iBoxx SGD Corporate Bond Index. Refers to annual yield.
China’s capital markets have expanded significantly in recent years. The combined market capitalisation of the exchanges in Shanghai, Shenzhen and Hong Kong – plus US-listed American depositary receipts (ADRs) – is USD 18.8 trillion (see chart). This is significantly higher than the USD 10 trillion market cap of euro-area equities4. Access to such a large market provides attractive opportunities for investors to gain further exposure to China’s growth story.
Major stock exchanges for China equities vs euro area
Source: Shenzhen Stock Exchange, Shanghai Stock Exchange, Hong Kong Stock Exchange, Bloomberg, Allianz Global Investors. Data as at 31 December 2020. The total figures are for comparison only. The stocks included may be listed in more than one exchange. Offshore China stocks are defined based on companies with ultimate parent domiciled in China. Suspended stocks, investment funds and unit trusts are excluded.
The outlook for China equities is underpinned by government investment in “new infrastructure” – foundational technologies such as artificial intelligence and electric vehicles. These are areas where China wants to reduce its reliance on foreign technologies and become a global leader – and Chinese companies have been benefiting. Case in point: the number of patent filings in China grew more than 450% between 2009 and 2019 (see chart), dwarfing the total number of annual patent filings by the world’s other top economies.
Annual patent filings of five largest economies
Source: World Intellectual Property Organization. Data as at December 2019.
China’s state-owned enterprises once held outsized influence over the country’s economy, but significant reforms drove down their share of GDP from 50% to 30% over the last 15 years. In addition, non-strategic SOEs – such as local consumer or technology businesses – are now behaving more like profit-seeking entities. China is also the youngest market regionally, meaning Chinese companies have been part of the region’s major benchmark index for the shortest amount of time. It’s an indication that much of the investment activity that previously took place in private and venture-capital markets is increasingly accessible to investors in listed equity markets. As Chinese equity indices have changed over time (see chart), markets have become more dynamic and more reflective of where the economy is headed.
China’s equity market composition by company type and location
Source: Wind Data Service, Gavekal, Macrobond Financial. Data as at 31 December 2019.
Some investors may have previously questioned China’s corporate governance standards, but things are changing. Use of international auditors and accounting standards is growing, with every listed Chinese company required to file quarterly reports and end its fiscal year on 31 December. Moreover, an increasing number of state-owned and privately owned enterprises offer employee stock ownership programmes (ESOPs; see chart). This helps turns employees into shareholders with an active stake in the company’s success.
Number of China A-share companies with ESOPs
Source: Wind. Data as at 30 November 2020.
Domestic retail investors in China dominate the market for A-shares and account for more than 80% of daily turnover5. (Markets with high turnover ratios are generally easier to trade because they’re more liquid – meaning more investors are buying and selling.) With the investment culture in China focused more on momentum and short-term trading, the stock turnover ratio of China A-shares is among the highest in the world (see chart).
Stock turnover of China A-shares vs other major markets
Source: World Federation of Exchanges, Allianz Global Investors. Data as at 31 December 2020. Turnover is the total value of shares traded during the period divided by the average market capitalisation for the period.
Volatility in China’s equity markets has sometimes been high – but perhaps surprisingly, during the peak of the pandemic crisis in 2020, China was less volatile than the US (see chart). There were only three days, for example, when China’s markets moved by more than 5% on a daily basis, compared with 10 days in the US. And while much of the current A-share trading activity is driven by retail investors, China’s equity markets overall are likely to become more influenced by institutional investors over time. This should help push volatility levels closer to those of the so-called more developed markets.
Rolling 30-day volatility in 2020 (US stocks vs China A-shares vs all China equities)
Number of days in 2020 with more than +/5% daily movement
Source: Refinitiv DataStream, Bloomberg, Allianz Global Investors. Data as at 31 December 2020. Volatility figures are annualized. US stocks are represented by the S&P 500; all China equities by MSCI China; China A-shares by MSCI China A Onshore. For index definitions, visit S&P Global and MSCI. Past performance is not indicative of future performance. Investors cannot invest directly in an index.
China has many stock exchanges and share classes – reflective of the depth and breadth of its economy – and they all have their own important characteristics. Even within China A-shares, the different listing venues offer varying exposures to sectors, market caps and SOEs. Regional macroeconomic differences can also affect shares: for example, US market performance influences US-listed Chinese ADRs. The net effect of these differences can be seen in the wide dispersion of performance by stock exchange (see chart). Investing across China’s exchanges can bring additional diversification benefits, but knowing the nuances of the marketplace is key.
Calendar-year return for different China equity markets
Source: Thomson Reuters Datastream, Allianz Global Investors. Data as at 31 December 2020. Shanghai-listed stocks are represented by Shanghai SE Composite Index; Shenzhen-listed stocks by Shenzhen SE Composite Index; Hong Kong-listed stocks by Hang Seng China Enterprises Index; and ADRs by S&P/BNY Mellon China ADR Index. For index definitions, visit: China Securities Index Co..; Hang Seng Indexes; and S&P Dow Jones. Past performance is not indicative of future performance. Investors cannot invest directly in an index.
China A-shares have a correlation of 0.21 with global equities over the last 10 years (see chart). That means China A-shares move in the same direction as global equities only 21% of the time. Or looked at another way, almost 80% of the time they move in a different direction. (In comparison, US and global equities have a correlation of 0.946.) Holding A-shares in a global portfolio may help generate a better risk-return profile. This could be particularly beneficial during steep market drops like those seen during the Covid-19 pandemic, when some highly correlated asset classes fell in tandem.
Correlation of A-shares with major equity markets
Source: Bloomberg, Allianz Global Investors as at 31 December 2020. Correlation data is calculated based on historical return of respective MSCI indices for the past 10 years, using weekly USD return. China A-shares represented by MSCI China A Onshore Index; HK-listed China stocks by MSCI China Index; APxJ equities by MSCI AC Asia ex Japan Index; global emerging market equities by MSCI Emerging Markets Index; Japan equities by TOPIX Index; US equities by S&P 500 Index; European equities by MSCI Europe Index; world equities by MSCI World Index. For index definitions, visit: MSCI; Japan Exchange Group (TOPIX); S&P Global. Past performance is not indicative of future performance. Investors cannot invest directly in an index.
The Shanghai and Shenzhen Stock Connect schemes that launched a little over five years ago helped integrate Chinese equities into the global financial system by making it easy to invest across borders. For example, investors outside of mainland China can use the Hong Kong exchange to buy A-shares in Shanghai or Shenzhen (known as a “northbound” trade). In “southbound” trades, mainland China residents use the Shanghai or Shenzhen exchanges to buy Hong Kong-listed stocks. Since the Shanghai Stock Connect opened in November 2014, Chinese equities have enjoyed 62 months of “northbound” inflows with only 13 months of outflows (see chart). Notably, the ongoing inflows have occurred despite economic and political volatility, implying a fundamental shift towards greater global investment in China.
Monthly northbound buying via Stock Connect (RMB billions)
Source: Wind, Allianz Global Investors. Data as at January 2021.
Some of the most prominent global stock indices – the benchmarks against which many investors measure their performance – have been adding Chinese stocks in increasing numbers. This reflects the growing importance of China to the global equity markets. It’s likely also a sign that more foreign investment will be flowing into the region in the future. But compared with China’s economic influence and market scale – it accounts for 16.9% of global economic output, among other factors – the country may still be under-represented on benchmark indices (see chart). Investors may want to consider allocating more to China than benchmarks do.
Key statistics on China and China equities
Source: FactSet, MSCI, Goldman Sachs Global Investment Research. Data as at 31 December 2020.