FTSE Russell’s recent announcement that it will include Chinese government debt to its flagship World Government Bond Index (WGBI) is another important milestone for China’s financial markets. FTSE Russell is the latest of three main index compilers to add Chinese debt after Bloomberg Barclays and JPMorgan Chase & Co. As WGBI is predominantly a developed market index, it serves as a validation that China is considered to be as significant as many of the developed markets and no longer just another emerging market.
Read MoreThe index inclusion is expected to commence in October 2021 and will be phased-in over 12 months. The commencement date is subjected to final affirmation in March 2021. After full inclusion, it is estimated that China’s weight could reach up to 5.7% of the overall index. It will also represent the sixth largest market in the index, following the U.S. (33.8%), Japan (16.7%), France (8.2%), Italy (7.3%) and Germany (6.0%). The Chinese bond market has grown tremendously over the years, as inflows from abroad have jumped nearly 40% per annum since 2017. The organic growth of China’s bond market, coupled with the impending inclusions, mean that foreign investors cannot afford to ignore China’s bond market for much longer. Foreign ownership of Chinese government bonds currently stands at 3% (as at end August 2020), substantially below levels seen in Japan (20%) and the U.S. (40%).
The inclusion will strengthen China’s foothold among international investors. It is estimated that index-related flows will account for approximately USD 140 billion over the phase-in period. This will be a major game changer for a market that has seen limited foreign participation despite having grown to become the second largest bond market in the world.
Meanwhile, China has made a number of reforms aimed at deepening its capital markets by facilitating direct financing and enhancing the availability of derivative products. Some initiatives include the further relaxation of Qualified Foreign Institutional Investor (QFII) and Renminbi Qualified Foreign Institutional Investor (RQFII) restrictions in November 2020. We believe more market-friendly initiatives will continue as China seeks to address investors’ demands for better market accessibility and improvements to liquidity.
We believe China's inclusion into all three major global bond indexes is a key milestone for China's financial market liberalisation process and will facilitate the broader internationalisation of the RMB. Notably, the 10-year China Government Bonds offer an attractive yield pick up of 243 basis points over the 10-year U.S. Treasuries (as of end-November 2020).
Read MoreIn the near term, with the Chinese government expected to maintain an accommodative monetary policy to stabilise China’s economy, the environment should generally be supportive of Chinese bonds. More importantly, as the Chinese bond market is still largely driven by domestic forces, its low correlation to both developed and emerging market bonds potentially provides investors with diversification benefits.
In summary, the increase in fund flows, improving market access and diversification benefits all point to China bonds becoming, in the fullness of time, an important component of global bond portfolios.
| Major bond index | Est. passive AUM (USD billions) | Est. Weight | Est. Inflows (USD billions) |
|---|---|---|---|
| JP Morgan Government Bond Index - Emerging Market | 202 | 10.0% | 20 |
| Bloomberg - Barclays Global Aggregate | 2,500 | 6.0% | 150 |
| FTSE Russell - World Government Bond Index | 2,500 | 5.7% | 142.5 |
Source: Goldman Sachs Global Investment Research I November 2020
Source: Bloomberg I November 2020