Update Magazine II/2021 DOWNLOAD THE COMPLETE MAGAZINE
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1  Using long-term trends for clever investment decisions

Setting aside long-term structural trends, such as RMB internationalisation and the liberalisation of the onshore bond market, China’s low correlation with other asset classes offers a more immediate and tangible impact to investors’ portfolios, through portfolio diversification and an improved risk/return profile.

2  The convincing arguments for China Government bonds

The increase in US Treasury yield this year was quite notable. The chart below exhibits the yield curve movement of US Treasury bonds, in blue, and China Government bonds, in red, during the first quarter of 2021. The dotted line represents the curve at the end of 2020, and the solid line represents the yield curve on 31 March 2021.

A/    YIELD CURVE CHANGES IN Q1 2021 (CHINA GOVERNMENT BONDS VS US TREASURY BONDS)

Source: Allianz Global Investors, Bloomberg as at 31 March 2021. The above is for illustrative purposes only and is not a recommendation or advice to buy or sell. Past performance, or any prediction, projection or forecast, is not indicative of future performance.

3  Risk spread plus opportunities for a return

The upward movement in the US Treasury bond yield curve is extremely evident, and in fact many global bond markets moved in tandem with US Treasury bonds. However, China Government bonds were quite resilient amid the recent US Treasury sell-off.

Historically China onshore bonds have shown low to negative correlation with other asset classes, which leads to diversification benefit and an improved risk/return profile. This is captured in the return correlation Chart A/ and Chart B/ below.

Chart B/ shows the 3yr return correlations of China’s onshore bonds against various global asset classes, converted to US dollars. This means that both the returns from the bonds and the currency exposure have been considered. Notably, we see a negative correlation with US Government bonds at the bottom. It also shows China onshore bonds’ low correlations with other major bond markets, such as emerging market bonds and global bonds. The red bar represents China’s onshore bonds’ correlation with China A-shares equities measured in RMB. Its negative correlation with China A-shares equities supports the case that China’s onshore bonds complement China A-shares equities, and therefore improve the risk/return profile in a complete China portfolio.

The low correlation argument holds true over various time intervals (Chart B/). This strengthens the case that China onshore bonds bring potential diversification benefits, and thus improve the risk/return profile of your overall portfolio.

B/    3YR CORRELATION BETWEEN CHINA GOVERNMENT BONDS AND OTHER ASSET CLASSES (IN USD)

Source: Allianz Global Investors, Bloomberg, as of 31 March 2021. The above is for illustrative purposes only and is not a recommendation or advice to buy or sell. Past performance, or any prediction, projection or forecast, is not indicative of future performance.

4  China onshore bonds’ risk/return characteristics

When we compare the volatility of China’s onshore bond market to other sovereign bond markets, we find that its volatility profile is more akin to developed market bonds, rather than emerging market bonds. Unlike many emerging market local currency bonds, which show a sharp increase in USD volatility due to the high FX volatility of many emerging market currencies, China onshore bonds’ USD volatility has been only marginally higher than its local currency volatility (see Chart C/).

C/    CHINA GOVERNMENT BONDS’ VOLATILITIES IN COMPARISON TO OTHER GLOBAL GOVERNMENT BOND MARKETS (IN USD)

Source: Bloomberg, FTSE Fixed Income LLC, J.P. Morgan Securities, Inc., and Thomson Reuters Datastream as at 31 March 2021. Notes: Volatility based on annualised standard deviation of monthly total returns. China is represented by the J.P. Morgan GBI-EM China Broad Index, Developed Markets is represented by the FTSE World Government Bond Index, United States is represented by the Bloomberg Barclays US Treasury Index, and Emerging Markets is represented by the J.P. Morgan GBI-EM Global Diversified Index. The above is for illustrative purposes only and is not a recommendation or advice to buy or sell. Past performance, or any prediction, projection or forecast, is not indicative of future performance.

Historically, many emerging market local currency bonds have shown high FX volatility, given their large dependency on foreign capital to fund government borrowing. This is not the case for China, which has been running a current account surplus, and is therefore not dependent on foreign capital. In fact, foreign ownership in China’s onshore bond market is still very low at 3%, because the onshore bond market used to be partially closed to foreign investors. This has led to a higher risk-adjusted return (return/volatility) of China’s onshore bonds compared to overall emerging market local currency bonds (see Chart D/).

D/    CHINA ONSHORE BONDS’ RISK-ADJUSTED RETURN IN COMPARISON TO OTHER GLOBAL GOVERNMENT BOND MARKETS

Risk-adjusted return (return/volatility)

Source: Bloomberg, FTSE Fixed Income LLC, J.P. Morgan Securities, Inc., and Thomson Reuters Datastream as at 31 March 2021. Notes: Volatility based on annualised standard deviation of monthly total returns. China is represented by the J.P. Morgan GBI-EM China Broad Index, Developed Markets is represented by the FTSE World Government Bond Index, United States is represented by the Bloomberg Barclays US Treasury Index, and Emerging Markets is represented by the J.P. Morgan GBI-EM Global Diversified Index. The above is for illustrative purposes only and is not a recommendation or advice to buy or sell. Past performance, or any prediction, projection or forecast, is not indicative of future performance.

5  China onshore bonds for portfolio diversification

In summary, China onshore bonds’ low correlation with other asset classes brings investors diversification benefits from the investors’ strategic asset allocation point of view. Not to mention that its stable return and lower volatility have led to a superior risk/return profile on a standalone basis. This is in addition to China onshore bonds’ higher nominal yield, which is rare in today’s yield-starved environment. We believe that the overall investment environment is in favour of China onshore bonds allocation. China’s onshore bond market has become ever more accessible to foreign investors, and the opportunity is too big to ignore. We believe that investors can benefit from its long-term capital appreciation potential, as well as from its contribution to portfolio diversification.

6  Allianz Renminbi Fixed Income

For investors looking to be part of the long-term structural trends such as RMB internationalisation and the liberalisation of China’s onshore bond market, which offer higher yield carry and diversification benefits, Allianz Renminbi Fixed Income provides access to the opportunities in the onshore bond market, with a strong quality tilt. The fund primarily invests in rates bonds (China central government bonds and policy bank bonds), which form the fundamental backbone of the fund, providing high quality onshore exposure, while also having some exposure to credit bonds across onshore and offshore China bond markets, in order to capture yield enhancement opportunities.

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