The Daily Update: China Bond Funds

According to data released last week by China Central Depository & Clearing Co and the Shanghai Clearing House, foreign investors held a record amount of Chinese yuan bonds at the end of May. Holdings by offshore investors of bonds traded in China’s interbank market stood at over 3.6 trillion yuan or USD575bn at the end of the month.

As we have written before we know that the local Chinese debt markets look very attractive to investors, however we have always thought that the only issuers international investors should consider should be the central government issuance, and if absolutely necessary the policy banks too. All other credits should be avoided if possible as it is very difficult to figure out which credits will be supported, and which will not. More importantly, if investors have exposure to RMB denominated assets then the major driver of returns is the exchange rate; why push to get an extra few basis points in return from holding non-government issues when the Renminbi may appreciate significantly? The risk-reward does not warrant this.

The main question is why hold RMB denominated debt in the first place when it’s sub-optimum to do so? Owning US dollar Treasuries 10 year at a yield of 1.55% with an overlay into Renminbi, CNH, you currently pick up 2.5% per annum on average so a total yield of over 4%, far more than China governments, at just over 3%; additionally you have the US Federal Reserve backing you as a buyer. If like us you diversify across Asia securing AA rated sovereign issuance, and not BB as per the majority of China Bond funds, and then overlay with CNH, you get high-quality investment grade bonds at a yield of around 2.5% and a 5% yield with the currency, plus potential for capital gains on the bonds.

Of course, there are risks not only in China, but around the globe in the current climate, however, there is no need for investors to expose themselves to those risks unnecessarily if the primary driver of returns is in fact the currency above anything else. Our funds, where permitted, roll one-month CNH exposure, through the forex forward market, buying CNH forward the carry is built into the price of the forex contract and on average the one-month maturity yields 2.5% on an annual basis.

We continue to believe that investing in an investment grade pan-Asian bond fund, that although not 100% invested in Chinese bonds, has the bonus of the trickledown effect from China is a far better way of not only benefiting from China exposure but also the protection of capital.

As many will know Stratton Street has been managing unconstrained credit portfolios since the mid-2000s. Our longest running strategy is a Renminbi Bond fund (launched in 2007) which has produced an annualised return of 8.62% (USD A Class since inception as at 30 April 2021) by investing in the credits of the world’s wealthiest and least indebted nations, economies whose net foreign assets dwarf that of most developed nations. We are close to launching a UK domiciled and FCA regulated version of the Renminbi Bond fund due to an increase in demand from investors wanting to diversify their fixed income portfolios into less correlated, high quality credits, that offer greater value and yield than is available in developed market investment grade credit.

Please do not hesitate to ask for further information.

Enjoy your day.