Investors are long familiar with the influential role China plays in the global economy and the vast potential of its domestic capital markets. The US$13.9 trillion Chinese bond market¹ has grown more than sixtyfold over the past 20 years, from US$214.6 billion in 2000, and has overtaken Japan as the second largest in the world. While the government bond yields for most developed markets have approached zero or even negative on the back of massive quantitative easing, China offers the highest government bond yield¹ among the world’s largest fixed income markets.
 

The world’s top seven bond markets¹ 
(by market size in US$ trillion)

The launch of Bond Connect and inclusion of Chinese bonds in major indices⁴ have brought about ample investing opportunities for Chinese bonds, where foreign ownership remains at a relatively low level. Index inclusion in major global fixed income indices will likely lead to over US$250 billion of passive inflows to the Chinese bond markets⁵.
 

Not all Chinese bonds are the same

The world of Chinese bonds is composed of three distinct markets: 

• CNY-denominated onshore
• CNH-denominated offshore 
• foreign currency-denominated (mostly in US dollars)

Different segments of Chinese bonds come with distinct characteristics. Relatively small in size, China’s offshore bond markets have seen issuers of higher quality in general, with a forecast default rate for 2020 similar to that of Asia and lower than those of emerging markets (EM) and the US.
 

Default rates of high-yield corporate bonds⁶ across different regions⁷

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Potential diversification³ benefits

In times of uncertainty, allocating to low or uncorrelated assets could help diversify³ investment sources within a portfolio. Both onshore and offshore China bonds exhibit a lower correlation with global aggregate and developed market bonds when compared with those in EM, while offering relatively attractive risk-adjusted returns.
 

Relatively low correlation between China and global aggregate bonds⁸

In addition, higher allocation to Chinese assets could mean greater currency diversification³. Getting exposure to domestic Chinese asset markets means getting Chinese renminbi (RMB) exposure. The RMB became a reserve currency in 2015, but so far has not gained significant traction in terms of usage. This could change now that investors have access to several assets priced in RMB. 
 

Income potential of Chinese bonds

Risk-free rates and cash returns are likely to stay low for an extended period of time as we expect the recovery process from the acute respiratory pandemic’s economic fallout to be gradual. In times of market uncertainty and with the global economy in a recession, it has become tougher for global investors to find income.

The income potential of Chinese bonds is becoming more appealing. Chinese government bond yield, for example, is relatively attractive compared with US Treasury yield even after hedging⁹.

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Conclusion

Chinese bonds look set to become more prevalent in bond investors’ portfolios² with initiatives such as Bond Connect and the inclusion in major indices⁴. As the search for income becomes tougher, investors could consider the US$13.9 trillion Chinese bond market¹ for potential income and diversification³ opportunities. 

Provided for information only based on market conditions as of date of publication, not to be construed as investment recommendation or advice. Forecasts/ estimates may or may not come to pass.

1. Source: J.P. Morgan Asset Management, Bank for International Settlements (BIS). Market size data as of 3Q 2019. Government bond yields data as of 30.04.2020.
2. For illustrative purposes only based on current market conditions, subject to change from time to time. Not all investments are suitable for all investors. Exact allocation of portfolio depends on each individual’s circumstance and market conditions.
3. Diversification does not guarantee investment return and does not eliminate the risk of loss.
4. Indices may not include fees or operating expenses and are not available for actual investment.
5. Source: Wind, ADB Research, JP Morgan. Data as of 30.09.2019. 
6. High-yield credit refers to corporate bonds which are given ratings below investment grade and are deemed to have a higher risk of default. For illustrative purposes only, exact allocation of portfolio depends on each individual’s circumstances and market conditions. Yield is not guaranteed. Positive yield does not imply positive return.
7. Source: J.P. Morgan. Data as of 30.04.2020.
8. Source: J.P. Morgan Asset Management, Bloomberg, USD return, data from 31.12.2004 to 31.03.2020. Indices used: SSE Composite Index (Shanghai A-Shares), S&P 500 Index (US Equities), Bloomberg Barclays Global Aggregate Index (Global Aggregate Bonds), J.P. Morgan Asia Diversified Index (Asian markets shown), J.P. Morgan Government Bond Index (the rest of the markets shown). Past performance is not indicative of future performance. Investors should note that different asset classes have varying risk/return profiles. Indices may not include fees or operating expenses and are not available for actual investment.
9. Source: Bloomberg and J.P. Morgan Asset Management. Data as of 18.05.2020.
10. Source: J.P. Morgan Asset Management. Ex-dividend date of the USD (mth) Class is 08.05.2020. The USD (mth) Class aims at monthly distribution. Dividend rate is not guaranteed. Distributions may be paid from capital.^{Refer to important information 3}. Positive distribution yield does not imply positive return. Annualised yield = [(1+distribution per unit/ex-dividend NAV)^12]-1. The annualised dividend yield is calculated based on the monthly dividend distribution with dividend reinvested, and may be higher or lower than the actual annual dividend yield.
11. Source: J.P. Morgan Asset Management, MSCI. Data as of 30.04.2020. Holdings, exposures and allocations for actively managed portfolios are subject to change from time to time. These represents the GFICC team’s views under current market conditions, subject to change from time to time. Provided for information only, not to be construed as investment advice. Diversification does not guarantee investment return and does not eliminate the risk of loss.
12. Source: J.P. Morgan Asset Management, Moody’s, S&P, Fitch. Data as of 30.04.2020. The credit rating is based on the highest of Moody’s, S&P and Fitch. Average rating is the weighted average of the credit ratings of bond holdings (including non-rated bonds) and net liquidity. Holdings, exposures and allocations for actively managed portfolios are subject to change from time to time. These represents the GFICC team’s views under current market conditions, subject to change from time to time. Provided for information only, not to be construed as investment advice. Diversification does not guarantee investment return and does not eliminate the risk of loss.
13. Source: J.P. Morgan Asset Management. Data as of 30.04.2020. Holdings, exposures and allocations for actively managed portfolios are subject to change from time to time. These represents the GFICC team’s views under current market conditions, subject to change from time to time. Provided for information only, not to be construed as investment advice. Diversification does not guarantee investment return and does not eliminate the risk of loss.

Investment involves risk. Not all investments are suitable for all investors. Past performance is not a reliable indicator of current and future results. Please refer to the offering document(s) for details, including the risk factors. Investors should consult professional advice before investing. Investments are not similar to or comparable with fixed deposits. The opinions and views expressed here are as of the date of this publication, which are subject to change and are not to be taken as or construed as investment advice. Estimates, assumptions and projections are provided for information only and may or may not come to pass. This document has not been reviewed by the SFC. Issued by JPMorgan Funds (Asia) Limited.