Sharpe Ratio Shows China’s Yuan Is Best Asian Carry TradeFion Li and Kyoungwha Kim
A gauge of the yuan’s risks and rewards shows it is the most attractive carry trade in Asia, spurring demand for Dim Sum bonds as exports rebound.
The yuan’s Sharpe ratio, which measures returns adjusted for price swings, was 8.4 so far in the second half, compared with 3.7 for Thailand’s baht and 0.2 for India’s rupee. China’s ratio is second only to Argentina’s 25 among emerging markets. Yuan notes sold in Hong Kong completed a 21st straight week of gains, returning 2.3 percent since March 28, a FTSE Group and Bank of China Ltd. index shows.
Manufacturing in July rose at the fastest pace since April 2012 and exports drove a record trade surplus as Premier Li Keqiang cut small-business taxes and bank reserve ratios. The yuan gained 0.9 percent this quarter, paring 2014’s loss to 1.5 percent. Options traders are the most bullish on the yuan in eight months as the central bank signals it will tolerate gains.
“The yuan trade is becoming attractive again as China’s dynamics have improved and the currency’s volatility remains low,” said Ben Yuen, Hong Kong-based head of fixed income at BOCHK Asset Management, which oversees about $3.1 billion in assets. “Demand for Dim Sum bonds moves in tandem with expectations of yuan gains, which have been rising recently.”
The yuan rose beyond a daily reference rate set by the People’s Bank of China on Aug. 6, the first time that has happened since the currency’s trading range was doubled to 2 percent in March. The spot rate traded at 6.1469 per dollar as of 10:20 a.m. in Shanghai, a 0.1 percent premium over the central bank’s fixing. The median estimate in a Bloomberg News survey predicts the yuan will reach 6.14 by year-end. Twelve-month non-deliverable forwards rose to a two-month high today.
The currency has the second-lowest price swings in developing nations, just higher than the Hong Kong dollar which is pegged to the greenback. The yuan’s one-month implied volatility was at 1.48 percent today, down from this year’s high of 2.52 percent on March 20.
“Investors will feel more comfortable adding to their offshore yuan positions in a lower volatility environment,” said Rajeev De Mello, who manages $10 billion as Singapore-based head of Asian fixed income at Schroder Investment Management Ltd. “The appreciation of the spot relative to the fixing is also a positive signal. On the macro side, stronger exports and signs of a stronger economy are positive.”
The Sharpe ratio, named after Nobel laureate and Stanford University professor William Sharpe, is a measure of the excess return per unit of risk in holding a currency position. This is used to determine how well an investor is compensated, with a higher ratio translating to more of a reward.
One-month options granting the right to sell the yuan cost 0.283 percentage point more than contracts allowing purchases today, the smallest gap since January, according to data compiled by Bloomberg. The so-called risk-reversal rate fell 66 basis points from this year’s high of 0.945 in March. Options grant investors the right, but not the obligation, to buy an asset in a call or sell it in a put.
Exports from the world’s second-largest economy climbed 14.5 percent from a year earlier in July, the fastest pace in 15 months, customs data on Aug. 8 showed. Imports fell 1.6 percent, leaving a record trade excess of $47.3 billion. An official Purchasing Managers’ Index of manufacturing rose to 51.7 in July, the highest in more than two years. A reading above 50 signals expansion.
The growth numbers and an improving outlook for the yuan are helping shore up demand for China’s assets. The Shanghai Composite Index of shares climbed 1.6 percent in August, extending July’s 7.5 percent rally that was the biggest since December 2012. Dim Sum bonds returned 0.22 percent last week, the best performance since the five days ended Oct. 18.
“With a turnaround in sentiment toward the yuan, some bond funds are increasing their Dim Sum holdings or putting their cash to work,” said Crystal Zhao, a Hong Kong-based strategist at HSBC Holdings Plc, the largest underwriter of the offshore securities. “Overall, we expect the second half of this year to be better than the first.”
Optimism on growth was tempered last week as official data showed aggregate financing, the broadest measure of credit, tumbled to 273.1 billion yuan in July from 1.97 trillion yuan in June. A decline in property sales added to the concern, with data for the first seven months of 2014 showing an 8.2 percent drop from a year earlier.
Further appreciation in yuan will be limited if inflation stays below the government’s annual target of 3.5 percent, according to Brian Coulton, a London-based strategist at Legal & General Investment Management, which oversaw the equivalent of $759 billion of assets at the end of 2013. Consumer price increases haven’t exceeded 2.5 percent this year, with July’s growth at 2.3 percent.
Coulton sees the yuan gaining 1.6 percent to 6.05 per dollar by the end of next year, while Schroder’s Mello expects the yuan to rise 1 percent by Dec. 31.
Latest official figures suggests only limited intervention by the central bank, Dariusz Kowalczyk, a Hong Kong-based strategist at Credit Agricole CIB, wrote in an Aug. 15 note. Yuan positions at Chinese financial institutions accumulated from foreign-exchange purchases rose 37.8 billion yuan ($6.1 billion) in July, PBOC data showed Aug. 15. They fell in June after rising by the least in nine months in May.
China will exit day-to-day currency intervention and allow more market forces in deciding the yuan’s rate, Market News International reported Aug. 8, citing Ma Jun, chief economist of the central bank’s research department.
“China’s trade surplus surge in July has helped yuan demand,” said Legal & General’s Coulton. “If they had strongly resisted any subsequent appreciation by intervention, it would have generated the perception of a return to intensive management, which they don’t want either.”