What Sets Chinese Bonds Apart?

We have noted previously some of the attractive features of onshore Chinese bonds, particularly the currently attractive yield pickup of Chinese bonds against U.S. Treasuries. This yield pickup remains significant despite the recent selloff in U.S. rates this year while China bond yields have remained steady. Furthermore, the performance profile of the Chinese bond market sets it apart from other emerging markets bond markets. We believe a targeted exposure to China onshore bonds beyond what is available in a broader global exposure may be worth a closer look.

Most market participants and index providers consider China to be an emerging market, and by many traditional measures, it is (e.g. per capita income). At the same time, the Chinese bond market has unique features that distinguish it from the broader emerging markets. It is the second largest bond market globally—second only to the U.S.—meaning that its depth and breadth sets it apart from other emerging markets. Its currency plays an increasingly important role in global trade, and unlike other emerging markets, China is a primary driver, rather than beneficiary, of global growth.

We compare below the performance of the Chinese aggregate bond market (which includes sovereigns, policy banks and corporate bonds), against emerging markets and U.S. aggregate bonds. A few notable time periods are worth highlighting. First, Chinese bonds avoided the severe drawdown that emerging markets bonds experienced in early 2020, despite being the epicenter of the pandemic at the time.

Chinese bonds have outperformed U.S. aggregate bonds over the long-term, and have significantly outperformed year to date through February 28, 2021 amid a sharp increase in U.S. interest rates. Compared to emerging markets aggregate bonds, Chinese onshore bonds have provided slightly higher long term performance but without the same boom and bust return profile. From a risk-adjusted standpoint, measured by Sharpe ratio, Chinese onshore bonds look attractive relative to emerging markets aggregate bonds and in line with U.S. aggregate bonds (but with higher absolute returns).

China Onshore Bonds Compare Favorably to U.S. and EM Bonds

Source: Morningstar, MVIS, Bloomberg Barclays, and ChinaBond as of 2/28/2021. Onshore China Bonds is represented by the ChinaBond China High Quality Bond Index; Emerging Markets Aggregate Bonds is represented by the MVIS^® EM Aggregate Bond Index; U.S. Aggregate Bonds is represented by the Bloomberg Barclays U.S. Aggregate Bond Index. Standard Deviation and Sharpe ratio are based on monthly returns from February 2012 to February 2021. Yield and duration are as of 1/31/2021.

At the same time, as shown in the table above, the yield and duration profile of Chinese onshore bonds is attractive. The Chinese bond index includes A+/A1 rated sovereign and policy banks, and bonds rated AAA by local rating agencies, which generally corresponds to investment grade, while the broad emerging markets index has significant high yield exposure. Considering the quality difference versus emerging markets bonds, the similarity in overall yield may be attractive.

From a portfolio construction perspective, Chinese bonds may offer additional benefits. Over the past five years, the correlation of Chinese bonds to U.S. aggregate bonds is very low (0.10), indicating potential diversification benefits.¹ Correlation to broad emerging markets bonds is also quite low (0.36), and lower than that of the U.S. aggregate (0.42) or global aggregate (0.71) bond benchmarks.² Chinese bonds, particularly sovereigns, are included in most global benchmarks but at relatively small weights when compared to the size of the country’s bond market. Outsized exposure brings country specific risks, including the potential for increased defaults in the corporate sector. However the unique characteristics of the market performance profile relative to other emerging markets bonds may provide support to increasing exposure to China onshore bonds beyond what can be obtained through a broader global exposure.