A consequence of the COVID-19 pandemic is that developed market central banks have pushed policy rates to zero, while engaging in asset purchases to keep bond yields low. The struggle to generate income is likely to be more intense in the next few years until we find a sustained solution to the pandemic. 

Investment grade corporate credit has already rebounded strongly since the March market correction. Its credit spread narrowed from the peak of 387 basis points (bps) to 220bps, just above the 15-year average of 178bps. High yield corporate debt has also rallied. The gradual reopening from lockdown in the U.S. and Europe is giving investors hope that the worst of the economic recession is behind us and aggressive central bank actions are also pushing capital into these markets. 

Amongst emerging markets, we believe that the Chinese fixed income market has often been overlooked. Having grown rapidly in the past 10 years, it is now the second largest bond market in the world, behind the U.S. market liberalization. Various channels, such as the Bond Connect program, have made the onshore bond market more accessible to international investors. This has led to the inclusion of Chinese onshore fixed in some international fixed income benchmarks, such as the Barclays Global Aggregate Bond Index, leading to more inflows. 

Chinese government bonds are also offering higher yields relative to other government bonds with similar credit ratings. For example, 10-year Chinese government bonds have a yield of 2.7%. China’s sovereign debt is rated A+ by Standard & Poor’s, the same as Japan, and higher than Spain and Portugal, which all have much lower government bond yields than China. 

Another benefit of the onshore Chinese fixed income market is the low correlation with global fixed income, as shown by the bottom chart of Exhibit 1. This helps to provide additional diversification benefits to investors when they construct their portfolios.

EXHIBIT 1: CHINA BONDS

Source: J.P. Morgan Asset Management; (Top left) FTSE Russell, J.P. Morgan Economics Research, National Interbank Funding Center; (Top right and bottom) Bloomberg Finance L.P.
*Credit indices shown are yield-to-worst, government bond index shown displays yield-to-maturity. FTSE Dim Sum Bond Index (CNH China offshore credit), J.P. Morgan Asia Credit China Index (USD China offshore credit). **Bond market outstanding refers to the total U.S. dollar value of bonds (corporate and government) in the market and does not reflect mandatory prepayment. ***Other includes: Communications, Consumer Discretionary, Consumer Staples, Energy, Health Care, Materials, Technology, Utilities. ****Indices are Bloomberg Barclays Global Government Bond Index and Bloomberg Barclays China Onshore Government Bond Index. Past performance is not a reliable indicator of current and future results. Correlation data as of 30/04/20 due to data availability.
Guide to the Markets – Asia. Data reflect most recently available as of 31/05/20.

Investment implications

Chinese bonds can help investors generate income and diversify their portfolio. The recent depreciation in the Chinese yuan, prompted by the global recession and return of trade tensions between the U.S. and China, is a risk factor that investors need to take into account. They can manage this currency risk by considering U.S. dollar-denominated Chinese bonds in the offshore market.  

Many investors are also concerned with credit risk of Chinese companies and see the rise in defaults as a threat. We believe that the Chinese authorities are allowing more defaults to take place in order to reduce moral hazard, as well as to allow the corporate debt market to price credit risk more accurately. Clearly, there is a need to build a portfolio of Chinese fixed income that is well-diversified to limit the risk of exposure to a small number of issuers. In-depth research to understand corporate fundamentals is also critical to strike a balance between risk management and generating income and return. 

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