The emerging safe haven asset you might not own, but probably should

China onshore bonds are emerging as a new safe haven asset and Hayden Briscoe, Head of Asia Pacific Fixed Income, explains why

29 Mar 2019
  • While emerging markets bonds sold off in 2018, China government bonds outperformed;
  • Over a long-run time period China government bonds are showing all the traits you'd associate with safe haven assets;
  • We believe their position as a flight-to-quality asset will grow as China continues to reform, the index inclusion process progresses, and the RMB takes on a larger global role as a reserve currency.

While most emerging markets (EM) bonds sold off in 2018, one part of the EM bond universe outperformed.

Returning 9.2% in 2018, the Bloomberg China Aggregate benchmark outshone the 4.4% drop in the EM sovereign debt and the 14.6% drop in EM Equity benchmarks, according to Bloomberg data.

Returns by Asset Class Benchmark (%), FY 2018

We believe that's because the Bloomberg China aggregate is largely made up of China government bonds, which are emerging as an alternative safe haven asset to the more traditional safe haven assets like US Treasuries, gold, and the Swiss franc.

China government bonds are starting to behave exactly the way you would expect safe haven assets to during times of heightened volatility. During historic spikes in the widely-used Volatility Index (VIX) , yields on China government bonds tightened, indicating that investors increasingly look at the asset class as a safe haven.

China government bond yields (%-RHS) vs VIX Index (LHS), Jan 2, 2008-Dec 31, 2019

And there's two principal reasons for this:

  • China is a net creditor country: with current account surpluses and foreign exchange reserves of close to USD 3 trillion2 , China has an exceptionally strong external position. Furthermore, China's level of government debt as a % of GDP (65.1%) is far lower than the 116.9% in the US, and 235.4% in Japan3.
  • China government bonds offer attractive yields and low correlation:at the time of writing, China government bonds offer a real yield pick-up of between 80-200bps4 compared with similar assets in US, Japan, German, and UK. Additionally, China government bonds have low correlation ranging between 0.03 and 0.23 against other major global aggregate benchmarks.

Correlation of onshore China bonds with major global bond benchmarks, October 2005-September 2018 (USD)

And we see three specific trends that will bolster the position of China government bonds as safe haven assets in the future, namely:

  • Ongoing reforms and improving accessibility: we've seen tax exemptions and the introduction of block trading in the past 12 months, and we expect further moves from the Chinese government like widening the Bond Connect system to continue opening up the onshore market to international investors.
  • The process of index inclusion: Bloomberg's inclusion of Chinese bonds is, we believe, the start of a process through which over index providers, like FTSE Russell and JP Morgan, bring onshore bonds into their indices, with China government bonds likely being only the first bond class to be included.
  • The rise of the RMB as a reserve currency: Though the USD is a dominant reserve currency, a number of trends are playing out that will boost the RMB as an alternative. Specifically, the closer integration of Chinese onshore markets with the global financial system, the process of index inclusion, the growing role of RMB-denominated oil payments, and the rise of CHAPS as an alternative to the USD-dominated SWIFT payment system.

So with these trends in mind, plus compelling fundamentals, we believe that China government bonds may continue to emerge as a go-to, safe-haven asset, and that's something that all investors should be aware of.



Read more

Fixed Income

Fixed Income investments from a global player

UBS Asset Management in the United States

The website contains general information about UBS Asset Management (Americas), Inc., UBS Hedge Fund Solutions LLC, and UBS O'Connor LLC, collectively known as "UBS Asset Management". The information contained on this website does not constitute investment advice or a recommendation to purchase or sell any securities or other financial instrument or any particular strategy or fund. Market commentary, product information and related performance data available on this website has been compiled from sources believed to be reliable and is provided in good faith for informational purposes only. UBS Asset Management does not guarantee the accuracy, suitability or completeness of information contained on this website, and all such information, including but not limited to performance data and related metrics, is subject to change without notice. Certain content on this website is intended for institutional investors and their financial representatives only, and should not be relied upon by retail investors or members of the general public.

Market commentary and similar statements contained herein are based on current expectations and may be considered “forward-looking statements.” Actual future results, however, may prove to be different from expectations. The opinions expressed are a reflection of UBS Asset Management’s best judgment at the time of posting, and any obligation to update or alter any forward-looking statement as a result of new information, future events, or otherwise is disclaimed.

Investments involve risks, are not guaranteed and may not return the original principal amount invested. Past performance is no guarantee of future results. Investors should read all available product information carefully before making an investment decision, including information about applicable risks, fees and expenses. This website does not address the investment objectives, risk tolerance or financial needs of any particular investor. In addition, any statements regarding investment performance expectations, risk and/or return targets do not constitute a representation or warranty that such expectations or targets will be achieved.

This website is not intended for persons located in any jurisdiction where the availability of this website is prohibited or contrary to local law or regulation or would subject any UBS entity to any registration or licensing requirement in any such jurisdiction.

Please confirm you are a US resident to proceed.

Confirmation
Please select at least 1 checkbox