In the wake of the market turmoil caused by COVID-19, bond investors face the challenge of very low or even negative yields in most developed countries. Uncertainty about global economic growth has caused the volatility in many bond markets to increase sharply, while the monetary policies put into place by many global central banks as a result of the pandemic make interest rate hikes seem unlikely in the foreseeable future. Anyone wishing to invest in high-quality bonds the corresponding low risks must seek alternatives outside of the usual investment universe.
China is becoming increasingly important for bond investors
In times of negligible or even negative yields, especially on the government bonds of developed countries, it pays to consider China. Chinese bonds are being added to a growing number of global indices, resulting in higher cash inflows from international investors. There are also three long-term trends that underscore the growing significance of Chinese bonds.
China’s important position in the global economy: After impressive growth over the last 30 years, China is now the world’s largest retail market, a key global production site and the birth place of a growing number of innovative technologies.
A potential reserve currency: How fast the renminbi can establish itself as a global reserve currency depends on the stability of the Chinese economy and the further opening up of markets. The currency is likely to become more important, and investors in government bonds should take this in account.
China's pension reforms: China has an aging population. According to UN data, the number of people over the age of 65 will likely increase from 172 million this year to around 246 million in 2030. The pension system will need to be reformed in order to handle this growth and the growing need for pension funds. Similar to other countries, this will boost demand for bonds in order to generate retirement income.
However, we believe it makes sense to invest in Chinese bonds now.
Desirable features of Chinese bonds
- Chinese bonds offer more attractive yields than most reference indices for global government bonds. Because Chinese monetary policy is different in that it tends to be shaped by domestic factors rather than external ones, UBS Asset Management expects this to continue to be the case in future.
- China’s bond markets are less volatile than global bond markets overall. The main reason for that are the local banks, which hold the majority of the bonds and pursue a buy-and-hold strategy.
- There is little correlation between Chinese bond markets and other markets. China’s economic and political cycles are not heavily influenced by Western economies, US Federal Reserve policies or the volatility of the US banking sector.
- Chinese government bonds in particular have remained relatively stable during periods of volatility. They could therefore be a safe haven for global investors in the future.
- The costs of currency hedging against the onshore renminbi (CNY) are low, making this a good time to buy.
There are, of course, risks and they should by no means be ignored. Chinese corporate structures are complex and more opaque than companies in most developed markets, and companies have government links that need to be understood and taken into account, and it is paramount to understand the level and aspects of liquidity in the credit markets.
This makes local expertise and extensive networks on the ground all the more important. We are confident that our prominent presence in China, history of investing in Chinese financial markets, and leading position as a professional investment manager in China can help put investors in a position to benefit from these opportunities.