Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 328

The biggest change in markets in a generation

The recent inclusion in global bond indexes of China, the second largest bond market in the world, will be a tectonic shift for fixed income markets. It follows similar changes in equity markets. Global investors ranging from sovereign wealth funds, central banks, pension funds and even retail investors will dramatically increase their exposure to renminbi assets in coming years.

Key parts of China's onshore bond market – government and policy bank bonds – have been incrementally added to the Bloomberg Barclays Global Aggregate Bond Index and are expected to account for approximately 6% of the total index, forcing investors to revise their allocations. It will be a major adjustment in the construction of portfolios.

There has never been a change of this size for global indexes, coinciding with the growing importance of China as a major economic power. Demand for Chinese onshore bonds will come not only from index changes but also the wider desire for Chinese assets, with some central banks allocating as much as 25% of their fixed income assets to China.

In a world of low and negative interest rates, investors chasing yield will see China's current 10-year government bond yield of around 3.1% as attractive compared with 1.6% for US Treasuries and around 1% in Australia.

Five reasons Chinese bonds are worth considering

China offers a compelling opportunity to complement returns from traditional bond markets and help diversify investors' fixed income exposure. Here are some important reasons investors should take notice:

1. Yield. China government bonds offer positive nominal and real yields compared with developed markets. That's been a standout feature for the past three-to-four years, as shown below.

Real yields by country (%), August 2009 to August 2019


Source: Bloomberg. Real yields based on Core CPI. New Zealand based on Headline CPI, August 2019. Australia and NZ June 2019.

2. Liquidity. China's bond markets overtook Japan as the world's second largest in late 2018. As China reforms its financial sector and continues to develop bond financing channels, the market is expected to continue growing in the coming years.

3. Correlation. China bonds have a low correlation to global bond markets, giving a strong diversification benefit. Historically, China has had a 0.05 correlation to European bond markets, which has a 0.6 correlation with the US and 0.55 correlation with Japan (as at 27 September 2019, based on fortnightly returns of government bond markets since 3 October 2014, calculated by JPMorgan).

4. Downside protection. Given the higher relative yields and shorter duration profile of the China government bond universe, investors can expect smaller drawdowns (losses) during periods of rising bond yields compared with other developed markets.

5. Safe haven. Chinese government bonds show the traits of safe haven assets, with falls in yields during recent bouts of broader market volatility. China remains a net creditor nation and has the world's largest FX reserves, so no one will be calling China on its debt.

But despite all these points, investing in China can be a leap for more traditional investors. In part, that's because China is always in the news cycle and much of the coverage is sensationalist.

Four common concerns (or myths) around investing in China

#1 – China's economy is slowing. Yes, it is slowing – and that's a good thing. China's rapid growth of the past was fueled by unsustainable growth in debt and fixed asset investment. Now, China is committed to deleveraging and has shifted the economy toward the more sustainable growth drivers of consumer demand and services-led growth. This means slower but more sustainable growth for the long-term.

#2 – China has a debt problem. Debt is certainly high, but we don't see it as a source of an impending crisis, for three main reasons. Firstly, China's debt is drawn from one of the world's largest savings pools, so it is domestically financed rather than externally, giving little risk of a balance-of-payments crisis. Secondly, more than half of China's debt is concentrated within state-owned enterprises (SOEs), i.e. within the government and not the private sector. Finally, China still has a lot of growth potential. Unlike the Japan situation in the 1990s, China has many productivity gains ahead of it, so it has the room to grow its way out of the debt to some extent.

#3 – Investors can't get in or out of China's markets. Not true. Recent index inclusion and the opening of the China Interbank Bond Market Direct and Bond Connect channels means full access to onshore China bond markets, with ready access to investment capital via these channels. We see it as unlikely that China will implement capital controls for foreign investors given its commitment to becoming one of the world's major developed bond markets and in integrating with the global financial system.

#4 – International investors aren't convinced by China. Also not true. Official data shows sustained growth in international investors' holdings of onshore China fixed income. In fact, total holdings have tripled since January 2016, and recent trends have seen acceleration, as shown below.

Overseas investors' holding of onshore fixed income in China (RMB trillions), Jan 2016-Jun 2019


Source: People's Bank of China, August 2019

The most fundamental shift

The inclusion of China's onshore bond market into major global bond indices started with Bloomberg in April 2019, and this has now broadened with JP Morgan recently announcing index inclusion plans. This impacts a wide range of global bond investors as passive (i.e. index) funds that follow these major indices must now invest in China bonds, and active managers must take a view given the major benchmarks will include parts of the China onshore bond market.

This shift is expected to lead to as much US$500 billion of inflows into China's markets from Bloomberg bond index inclusion alone, and this has three important implications.

  1. It is happening because the world's biggest index providers have seen China's recent reform efforts and now deem China as 'safe-to-swim'.
  2. Allocation to China will become a mandatory, not optional, allocation for millions of investors worldwide.
  3. The massive influx of global investor capital will put downward pressure on yields, and that means it is time for investors to take the opportunity now.

This phenomenon is occurring across more asset classes than fixed income. MSCI included China equities in its emerging markets index in 2018. FTSE Russell and S&P Dow Jones have since followed, a reflection of China's increased efforts to integrate its capital markets into the global financial system.

The compelling case for China fixed income is one of many opportunities uncovered by actively exploring the global fixed income opportunity set and why it pays to employ a truly global and diversified approach to investing, particularly in a world of lower – and increasingly more negative – bond yields.

 

Hayden Briscoe is Head of Asia-Pacific Fixed Income, UBS Asset Management, a sponsor of Firstlinks. Learn more about UBS Diversified Fixed Income (DFI) here. This article is general information and does not consider the circumstances of any investor.

More articles and papers from UBS can be found here.

 

 

RELATED ARTICLES

A closer look at defensive assets for turbulent times

Why allocating more to fixed income now makes sense

Will the Year of the Dragon be good for markets?

banner

Most viewed in recent weeks

16 ASX stocks to buy and hold forever, updated

This time last year, I highlighted 16 ASX stocks that investors could own indefinitely. One year on, I look at whether there should be any changes to the list of stocks as well as which companies are worth buying now. 

UniSuper’s boss flags a potential correction ahead

The CIO of Australia’s fourth largest super fund by assets, John Pearce, suggests the odds favour a flat year for markets, with the possibility of a correction of 10% or more. However, he’ll use any dip as a buying opportunity.

2025-26 super thresholds – key changes and implications

The ABS recently released figures which are used to determine key superannuation rates and thresholds that will apply from 1 July 2025. This outlines the rates and thresholds that are changing and those that aren’t.  

Is Gen X ready for retirement?

With the arrival of the new year, the first members of ‘Generation X’ turned 60, marking the start of the MTV generation’s collective journey towards retirement. Are Gen Xers and our retirement system ready for the transition?

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

What Warren Buffett isn’t saying speaks volumes

Warren Buffett's annual shareholder letter has been fixture for avid investors for decades. In his latest letter, Buffett is reticent on many key topics, but his actions rather than words are sending clear signals to investors.

Latest Updates

Investing

Designing a life, with money to spare

Are you living your life by default or by design? It strikes me that many people are doing the former and living according to others’ expectations of them, leading to poor choices including with their finances.

Investment strategies

A closer look at defensive assets for turbulent times

After the recent market slump, it's a good time to brush up on the defensive asset classes – what they are, why hold them, and how they can both deliver on your goals and increase the reliability of your desired outcomes.

Financial planning

Are lifetime income streams the answer or just the easy way out?

Lately, there's been a push by Government for lifetime income streams as a solution to retirement income challenges. We run the numbers on these products to see whether they deliver on what they promise.

Shares

Is it time to buy the Big Four banks?

The stellar run of the major ASX banks last year left many investors scratching their heads. After a recent share price pullback, has value emerged in these banks, or is it best to steer clear of them?

Investment strategies

The useful role that subordinated debt can play in your portfolio

If you’re struggling to replace the hybrid exposure in your portfolio, you’re not alone. Subordinated debt is an option, and here is a guide on what it is and how it can fit into your investment mix.

Shares

Europe is back and small caps there offer significant opportunities

Trump’s moves on tariffs, defence, and Ukraine, have awoken European Governments after a decade of lethargy. European small cap manager, Alantra Asset Management, says it could herald a new era for the continent.

Shares

Lessons from the rise and fall of founder-led companies

Founder-led companies often attract investors due to leaders' personal stakes and long-term vision. But founder presence alone does not guarantee success, and the challenge is to identify which ones will succeed in the long term.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.