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.

 

 

  •   16 October 2019
  • 3
  •      
  •   

RELATED ARTICLES

Higher yields are creating opportunities in global bonds

Asia in 2026: Riding AI, reform and a shifting global order

Bonds are copping a bad rap

banner

Most viewed in recent weeks

It’s time for LICs to die

A high-profile dividend cut and a prominent fund manager’s apology have reignited a long-running debate. If investors can access similar exposures more cheaply and efficiently elsewhere, what exactly is keeping LICs alive?

The retirement scorecard: how many of these questions can you answer?

From the maths of retirement, estimating spending and picking the right asset allocation to survive a poor decade, here are the questions every retiree – current or future – should be able to answer for themselves.

Testamentary trusts: Treasury has picked the wrong reading

A decades-old estate planning tool has survived one tax crackdown only to be caught by another. The surprise isn't who the reform is targeting, but who could end up paying the price for drafting choices made years ago.

How the typical Australian Family could save $844,350 in taxes

The value of a testamentary trust is not determined by wealth alone. Depending on circumstances, it can reduce the tax burden on inherited income, create efficiencies and help build intergenerational wealth.

The housing slide could become a crash

House prices are sliding across Australia, yet the most dangerous ingredient for a housing crash is still missing. If job losses surge amid growing economic risks, today's correction could become a historic property downturn.

Will investors be better or worse off under new housing tax changes?

Housing tax reforms have sparked warnings of market turmoil and promises of greater fairness. But after modelling nearly two decades of property data, the results suggest winners and losers may not be who many investors expect.

Latest Updates

Testamentary trusts: Treasury has picked the wrong reading

A decades-old estate planning tool has survived one tax crackdown only to be caught by another. The surprise isn't who the reform is targeting, but who could end up paying the price for drafting choices made years ago.

Latest from Morningstar

Does an American retirement rule work for Australians?

The 4% rule has survived decades of scrutiny, but Australia's retirement system changes the equation in ways most overlook. Before accepting or rejecting this rule of thumb, it pays to understand what really drives retirement outcomes.

Shares

Glencore lands on the ASX. Should BHP and Rio shareholders switch?

A coal-heavy miner with governance concerns isn't the obvious choice for investors. Yet, Glencore's ASX listing may offer something BHP and Rio can't. The challenge is working out whether the opportunity outweighs the risks.

Why does the system treat capital gains and losses differently?

Investors are often told not to let tax policy drive their investment decisions. Yet, under the new CGT rules, portfolio construction, volatility and even how assets are owned may have an outsized impact on their final outcome.

Economy

Three common sense reforms that Australia needs

What do frozen bank accounts, mortgage traps and pension penalties have in common? They're all symptoms of a system that makes life much harder. Yet the obvious solutions seem to have escaped the attention of Canberra.

Shares

The hidden cost of government debt for investors

Some of the important effects of rising public debt never make the headlines. Research shows the immediate effects may already be unfolding, influencing corporate behaviour in ways that many investors would never suspect.

Investment strategies

When do fundamentals matter?

Is fundamental investing losing its grip on markets? Investors continue to search for valuation-based explanations for every price move, but the dominant force behind short-term returns may be something else altogether.

Sponsors

Alliances

  • ASA-Logo-RGB-ActiveGreen-web.png

© 2026 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.