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Yuan Flight Drives China Dollar Bond Gains as Funds Blossom

  • China Inc.’s dollar yield premium drops to lowest since 2008
  • GF Fund says lower borrowing costs will spur China bond sales

A flight from yuan assets is helping cut China Inc.’s overseas borrowing costs to the lowest since the global financial crisis.

Demand for Chinese dollar bonds is surging as locals brace for more yuan losses, after the currency slumped 3.5 percent against the greenback in the past year. Banks sold 800 wealth-management products targeting U.S. currency assets in the first seven months, up 44 percent from a year earlier, research firm PY Standard estimates. Assets at Chinese funds allowed to invest in overseas bonds more than tripled to 13.6 billion yuan ($2.1 billion) in the six months through June 30, according to Shanghai-based Z-Ben Advisors.

The flood of cash is driving a rally in Chinese firms’ dollar securities that cut their yield premium over Treasuries 32 basis points this quarter to 269 basis points on Aug. 15, the lowest since January 2008, according to a JPMorgan Chase & Co. index. That’s still wider than the 126 basis point average spread for onshore yuan notes. GF Fund Management Co. sees falling borrowing costs and strong domestic investor demand fueling even more Chinese dollar bond offerings, after issuance jumped 16 percent this quarter from a year earlier.

“Yuan depreciation expectations still exist,” said Guangzhou-based Li Yaozhu, assistant fund manager for GF Fund’s overseas bond fund, which returned 17 percent in the past year. “Chinese investors’ demand for bonds from Chinese names will continue to increase.”

Sliding borrowing costs make it cheaper for firms to fund mergers and acquisitions, or to repay debt onshore. Chinese companies have announced $158 billion worth of overseas M&A deals so far this year, already surpassing 2015’s full-year record of $109 billion. In the domestic market, they are facing a record 3 trillion yuan of bonds maturing in the second half.

The nation’s firms sold $13 billion of dollar bonds in the offshore market this quarter, up from $11 billion in the same period of 2015, data compiled by Bloomberg show. The previous three quarters’ sales all declined from the year-earlier periods. Local government financing vehicles have sold $2.17 billion, compared with $850 million in the same period last year.

Chongqing Nan’an Urban Construction & Development Group Co., an LGFV in the southwestern municipality of Chongqing, returned to the offshore market to sell $200 million of 10-year dollar bonds last week, only a month after issuing $800 million of notes. The securities were mainly bought by Chinese banks and insurers, according to lead manager China International Capital Corp.

Gradual Expansion

“The fund flow from onshore China will benefit both high-grade and high-yield 
bonds offshore,” Gordon Ip, who manages the $1.9 billion Greater China High Yield Fund in Hong Kong at Value Partners Group Ltd. The fund has returned 11 percent this year, beating 80 percent of its peers. “The priority for the Chinese funds has been Chinese bonds but gradually they will also be open to buying other Asian bonds if the valuation is attractive.”

Investors are favoring state-backed issuers. The spread on state-owned metal trader China Minmetals Corp.’s 2025 bond over U.S. Treasuries declined 24 basis points this month to 201 basis points, compared with the average fall of just 8 basis points for Chinese firms’ dollar notes.

"China investors have been buying more than 50 percent of all recent Chinese deals,” said Avinash Thakur, managing director of debt capital markets at Barclays Plc in Hong Kong. “Some of these investors then repackage the product and sell to Chinese high-net-worth or retail investors.”

Goldman Sachs Group Inc. estimated $55 billion foreign-exchange outflows from China in July, compared with $49 billion in June.

“In the coming three years, Chinese companies’ dollar bond yields will continue to decline because of the yuan depreciation outlook,” said He Xuanlai, a Singapore-based analyst at Commerzbank AG. “A lot of the money from China can only buy China names because of their own risk limits.”

— With assistance by Lianting Tu, and Judy Chen

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