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China's government debt offers investors haven from trade fallout

China's government debt offers investors haven from trade fallout

Chinese government bonds are becoming more appealing to foreign investors, as they can offer a degree of immunity to the effects of the ongoing China-US trade war.

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By Meili Chen 06.09.2018

Chinese government bonds are becoming more appealing to foreign investors, as they can offer a degree of immunity to the effects of the ongoing China-US trade war, portfolio managers have claimed.

The tit-for-tat tariff battle between Beijing and Washington is set to escalate further with a new round of tariffs in the offing later this month. The long-running conflict has already had a detrimental impact on China’s stock markets and the yuan, which has slumped against the US dollar in recent months.

China has faced criticism for its protectionist policies in the past, but it is now making moves to offer overseas investors greater access to government debt, which is less exposed to the volatility of the trade standoff. When considering a few other technical factors, these bonds quickly become an attractive investment option.

Jason Pang, J.P. Morgan Asset Management Portfolio Manager, has attributed the emerging opportunity for investors to several key factors. Pang revealed that China’s bonds performed better than currency sovereign debt in other Asian countries during the first half of the calendar year as investors retreated to safe spaces due to the volatility of global stocks.

China’s government debt offers ample opportunity for foreign investors, as overseas holdings still only account for 7% of the total, and many have been making the move to buy government bonds even as they have pivoted away from equities. Bonds attracted net inflows of foreign cash during H1 2018.

Pang said that lower costs for hedging are one of the primary reasons why Chinese bonds are attractive for foreigners, and investment in this area can also act as insurance against currency risks. The fact that China’s bond market does not have an established connection with other markets means that it is not as likely to slump when turmoil is prevalent elsewhere.

"Because you have very low foreign representation in it, the country itself actually is less susceptible to foreign investment outflows, for bonds in particular," Pang added.

Erwin Sanft, E Fund Management Managing Director and Senior Portfolio Manager for International Investment, also supports the theme of bond immunity. He believes that the absence of correlation means that China’s bonds lack scale compared to other global markets and offer a haven from trade conflict.

"The trade conflict impacts on the currency, but in terms of direct impact on the bond market, very little, because the bond market has yet to really encompass the whole economy," Sanft said. A new “connect” program has boosted outside participation in China economy, helping foreign investors to make purchases via the semi-autonomous region of Hong Kong.

Chinese government bonds are also set to feature in the Bloomberg-Barclays Global Aggregate Index in 2019 after the addressing of a few remaining technical issues. This is likely to make the bonds even more attractive and drive foreign investment through the connect program further.

China recently approved a new trading measure that will waive tax on interest income for several years and provide portfolio managers with greater flexibility to manage a number of funds. “These back-to-back policy announcements demonstrate [Chinese] authorities' determination to accelerate the opening up of China's bond market,” HSBC noted in a report released last week.

Sanft believes that foreign investment will keep rising during the next year. He added: “And with the way now clear for inclusion, that will just continue. Frankly, this means that investors around the world who haven't yet had a good look at the onshore bond market have to really make a big effort from now on because it can no longer be ignored.”

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