Chinese government bond ETFs have been a favourite among investors this year, partly due to the country’s strong economic performance.
Bond ETFs are attracting a solid level of interest in 2020. According to Morningstar data, European investors have ploughed close to £30 billion of new money into bond ETFs in the first nine months of 2020. Assets under management in bond ETFs already account for 27% of all money invested in ETFs in Europe, and the prospects remain positive.
Yuan-denominated Chinese government bond ETFs have been a favourite among investors this year, netting more than £2.5 billion in inflows to the end of September. Interest in Chinese bonds is likely to have been partly driven by the rebound of China’s economy from the depths of the Covid-19 crisis.
China’s GDP grew by 4.9% year-on-year in the third quarter, up from 3.2% in the second. This has more than reversed the steep fall in output in the first quarter. This not only compares well with the still-struggling developed economies – for example, the Chinese yuan has appreciated strongly against the US dollar, clocking in a 4% gain year-to-date – but with many other emerging markets. In fact, investors have shed £4.1 billion over the same period from ETFs tracking multi-country local-denominated government bond indices over the same period.
The iShares China CNY Bond ETF (LSE:CNYB), the market-leading ETF in Europe that provides 100% exposure to yuan-denominated investment-grade bonds issued by the Chinese treasury and policy banks, has delivered returns of 5.7% year to date to the end of October in USD terms. By contrast, the iShares JP Morgan Emerging Market Local Government Bond ETF, which provides exposure to a basket of bonds from multiple countries, has dropped by 6.9%, also in USD terms.
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The exposure to China in the multi-country ETF is 8%, but the positive returns of that portion of the basket have been more than offset by losses from some of the many other countries that make up the index, which in the case of local currency denominated bonds can come both via bond prices and adverse foreign exchange trends.
The opening of the onshore Chinese bond market to international investors has accelerated in the last decade, and index houses have been incorporating this exposure into their suite of global emerging-market bond benchmarks in various stages.
Bloomberg Barclays started a phased inclusion in April 2019, which should be completed by the end of 2020. JP Morgan, arguably the index house of reference for emerging market debt, started the process in February 2020 and should also be completed at the close of the year. Meanwhile, FTSE Russell announced last September that it would begin a 12-month-phased process of inclusion of Chinese onshore bonds in October 2021.
The move by index providers acknowledges that nowadays most investors find it hard to reconcile the idea of investing in international bond markets – particularly emerging markets – and not include what has become the third-largest bond market in the world after the US and Japan.
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This move also serves as a handy reminder that indices – and by extension the passive funds that track them – are not immutable investment propositions. Quite the contrary, they can see significant mutations through time, and investors in passive funds – particularly those with a global scope – should keep track of these changes to ensure that the indices continue to meet their investment goals and risk tolerance.
ETF providers have identified fixed income as one of the key areas of growth in the next decade. This means an increased effort in terms of product development, providing investors with easy access to all sorts of market exposures, of which onshore Chinese bond ETFs are just an example.
The iShares CNY Bond ETF was only launched in July 2019 but has already amassed more than $4 billion in assets. It tracks the Bloomberg Barclays China Treasury and Policy Bank Bond index and comes with an ongoing charge of 0.35%.
In March 2020, UBS launched the UBS JP Morgan CNY China Government 1-10 Year Bond ETF. It tracks the JP.Morgan China Government and Policy Bank 20% Cap 1-10-year index, which caps exposure to policy bank bonds to 20%. It comes with an ongoing charge of 0.33%. Both ETFs are physically replicated. The average credit quality of the rated Chinese bonds is A+.
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