China is becoming less optional for investors. Debt from the Chinese government and key state banks is set to join the Bloomberg Barclays Global Aggregate, an influential bond index, in April. That follows similar moves to introduce shares listed in Shanghai and Shenzhen to MSCI and FTSE Russell stock indexes. Here’s what investors need to know.A borrowing boom means China’s debt market has grown to $12.42 trillion from $2.13 trillion in a decade, Bank for International Settlements data shows, and it could soon overtake Japan’s.
Local outfits dominate the market for sovereign yuan debt. They seek shelter in the relative safety of government bonds during times of stress, which has helped Chinese debt rally during global selloffs like the 2013 “taper tantrum.”
In countries like Indonesia and South Africa, foreign investors can sway bond prices and tend to run for the exits during bouts of trouble. The fact that China’s bonds behave differently increases their appeal to buyers eager to hold a diversified portfolio.
Trillions of dollars track major bond indexes and HSBC analysts estimate $150 billion will flow into Chinese debt thanks to Bloomberg’s move, which also affects two other indexes. Followers of this index include exchange-traded funds from BlackRock’s iShares unit and Deutsche Bank ’s asset-management arm under the Xtrackers brand.
JPMorgan has had Chinese government debt under review for inclusion in its key benchmarks since 2016. Those bonds are in an emerging-market index run by FTSE Russell but not yet in its main gauge. Those indexes previously belonged to Citigroup Inc.
Yields on lower-rated bonds have risen since late 2017, while those on better-rated peers have come down. Yields rise as prices fall.
The widening spread, or premium that buyers demand for buying riskier debt, shows investors are doing a better job of pricing risk, says Morgan Lau, fixed income portfolio manager at Fidelity International.
Newcomers will enter following a rally. Ten-year government debt yielded about 3.2% recently, down from 3.8% a year ago.
Bloomberg’s move is limited to securities issued by the central government debt and a few so-called policy banks—important state lenders like China Development Bank, which also have Beijing’s full backing.
Go farther afield, and things get more complicated. Local ratings firms grade most bonds AA or better, but those could translate into much lower BB or BBB ratings from global firms like Moody’s Investors Service and S&P Global Inc., said Tracy Chen, portfolio manager and head of structured credit at Brandywine Global in Philadelphia.
“The onshore ratings are pretty untrustworthy,” she added.
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