With the launch of the “Bond Connect,” China’s domestic bond market, the third-largest in the world, is heralding in a new era of foreign investments. Among those rubbing hands for the exciting change is BOCHK Asset Management Limited (BOCHK AM), winner of this year’s House Award in China Fixed Income. As one of the first witnesses of China’s market liberalization, Ben Yuen, Chief Investment Officer, Fixed Income, at BOCHK AM, shared with BENCHMARK what the future may hold for Chinese bond investors.
BENCHMARK (BM): China’s financial market liberalization has reached many milestones in recent years. As an award winning fund manager in China Fixed Income, could you tell us what that would mean for the onshore bond market?
Ben Yuen (BY): Sure. Overall, we are seeing an increasing global demand for CNY-denominated assets. Following the announcement of the European Central Bank (ECB) last year that it would be switching EUR 500 million worth of its foreign reserves to CNY, the German central bank also decided to include the Chinese Yuan in its own reserves. Besides, anecdotal evidence shows that, in the onshore bond market, rate bonds and banks’ Negotiable Certificates of Deposits (NCDs) attract more foreign interest. Foreign purchases of NCDs through Bond Connect reached RMB 33.4 billion as of 2017Q3, according to the Shanghai Clearing House’s data. Also, offshore investors’ total holdings of onshore interbank bonds in 2017 (through Bond Connect and other channels) amounted to RMB 348 billion, a 130% year on-year growth!
BM: That’s an amazing number! Moving to 2018, should we expect more game changers?
BY: One significant game changer is the highly probable inclusion of the onshore bond markets into at least one of the widely tracked international indices (e.g., JPMorgan’s Government Bond Index – Emerging Markets, Citibank’s World Government Bond Index, or Bloomberg Barclays Global Aggregate Index). This will likely attract significant foreign fund inflows into the onshore bond markets (especially for CGBs and policy bank bonds) starting in 2019.
BM: China’s bond market has become the world’s third-largest. Are there any risks associated with the surge in onshore issuance? How do you mitigate these risks?
BY: For foreign investors, the major concern regarding investing in the onshore market is the incomprehensive credit-rating system, which fails to meet international standards. According to domestic rating agencies, 37.7% of China onshore credit bonds are rated as AAA. However, many investment grade onshore issuers are usually rated non-investment-grade in the offshore Dim Sum bond market (e.g., Evergrande) by international credit agencies.
To cope with this disparity of credit-rating standards, we make a point of maintaining an internal rating system to track the credit matrix development of different bonds.
BM: China’s property bonds remain your key portfolio holdings despite the trimmed exposure. Will you continue to favor this sector in 2018? What other sectors are on your radar?
BY: We expect China’s property sector to stay stable. Although President Xi reaffirmed that “houses are built to be inhabited, not for speculation” during the National Congress last year, no new tightening policies have been introduced so far. We believe that the Chinese government is comfortable with the existing measures, and hence, we don’t expect any major housing-price fluctuations in 2018. Currently, the Chinese real-estate sector is highly transparent, with contract sales figures being reported on a monthly basis. We can easily identify any abnormalities by cross-checking with comparable issuers. That said, we remain vigilant on credit selection.
Within the Asian High Yield USD bond universe, we are now investing in the Chinese industrial sector and Indonesian corporate bonds, as well as the local currency bonds of some Asian or Emerging Markets, on a selective basis.
BM: Corporate governance is highlighted as one of your most important evaluation criteria in credit selection. However, collecting data, especially extra-financial information, from domestic companies could be a challenge. How do you overcome this?
BY: Yes, we do value the importance of corporate governance in our credit selection process, and that’s why we keep close connections with onshore corporate issuers and maintain regular dialogue with their management through telephone calls, offshore investor meetings, and on-site visits. Together with the insights provided by different onshore research houses that closely track onshore issuers, we can spot any abnormalities in issuers’ financial data and extra-financial information. With more and more Chinese corporates issuing bonds overseas, we have noticed appreciable improvements in information-sharing, a crucial element to satisfy offshore regulators and investors. BM