China Bond Opening Fails to Spur Asian Funds Wary of Policy

  • Investors concerned about political risks: Asahi Life Asset
  • More than 3 weeks after start, volumes on the link remain low

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Investors who were granted a new gateway to China’s $10 trillion bond market this month say accessibility was the least of their worries.

Tokyo-based Mitsubishi UFJ Kokusai Asset Management says it’s avoiding Chinese corporate notes now because of uncertainties about the nation’s policy outlook. Japan’s Fukokushinrai Life Insurance Co. is reluctant unless China improves its debt market infrastructure such as credit ratings. Samsung Asset Management in Seoul says it would need to invest in lower-rated Chinese debt to earn sufficient yields when currency hedging costs are considered, but it’s uncomfortable doing so because of a lack of transparency in the market.

Three weeks after China opened bond connect to let global investors buy the nation’s notes through Hong Kong, volumes on the system remain sparse. Six deals totaling 240 million yuan ($36 million) were conducted on Wednesday, compared with bond trading volume in the interbank market of 429 billion yuan on the same day, according to official Chinese data. While investors in Japan and Korea say the new system may boost foreign investment in the world’s third-biggest debt market, China’s past actions such as its intervention to prop up equities in 2015 have left them hesitant to dive in.

“Our clients have shown no appetite for bonds in mainland China even though they are interested in Southeast Asia. I suspect they are concerned about political risks,” said Yoshihiro Nakatani, a senior fund manager at Asahi Life Asset Management. “In China, authorities change rules all of sudden.”

The lack of enthusiasm presents a challenge as China tries to open up the market further and boost global use of the yuan.

The suddenness with which the bond connect was rolled out has also affected the reception, according to Edmund Goh, a fixed-income investment manager at Aberdeen Asset Management. “Usually foreign funds would take time to set up to be operationally ready to trade,” he said.

Deutsche Bank AG expected inflows to be slow in the third quarter because of technical and logistical adjustments related to setting up accounts, according to Liu Linan, Greater China macro strategist at the firm. “We expect investment interests to grow gradually over time, especially after RMB bonds are included into major global indices.”

Japanese investment trusts had less than 1 percent of their 10.835 trillion yen ($98 billion) in overseas bond holdings in China, data from Japan’s Investment Trusts Association show.

Mitsubishi UFJ Kokusai Asset Management invests in Chinese government bonds but doesn’t intend to get into corporate notes now because of concern that they could be affected by politics following a party congress later in the year, according to Hideo Shimomura, chief fund manager at the Tokyo-based firm, which oversees about $112 billion. The party congress is expected to set the tone for Xi Jinping’s second five-year term as president.

China’s aggressive efforts to stem a stock-market rout in 2015 are also making investors wary, says Shimomura. At the time, officials armed a state agency with more than $400 billion to purchase stocks, banned selling by major shareholders and told state-owned companies to buy equities.

Investor concerns that authorities won’t let foreign investors take out their money are “a bit unfounded,” according to Ashley Perrott, the head of pan-Asia fixed income at UBS Asset Management.

“I think the Chinese regulators and authorities are smarter than that,” said Perrott, whose firm oversees about $730 billion in assets. “They need the international investments, they need the inflows.”

See also: Chinese junk bonds are rallying despite default worries

One factor preventing investors from parking their money in Chinese bonds is that the notes aren’t included in major benchmark indexes. Citigroup Inc. said in March it’s set to add Chinese onshore sovereign bonds into three of its indexes in February next year, but not in its most widely watched gauge. Bloomberg Barclays Indexes, owned by Bloomberg, overhauled its China fixed-income gauges and started a Global Aggregate + China index in March, while stopping short of adding the nation to major benchmark indexes.

Inflated credit ratings are also a concern. China’s biggest bond clearing house has said some onshore corporate notes are “overrated” and local firms are “seriously” late in adjusting debt scores.

Investors need to see a “better pricing discovery mechanism” for the corporate bond market, said Jean-Charles Sambor, deputy head of emerging-market debt at BNP Paribas Asset Management. “So far, there is no real high-yield market in China.”

For corporate bonds, difficulty finding buyers and sellers for the securities is a worry at a time when government efforts to cut excessive company borrowings are fueling defaults.

“The liquidity in the corporate bond space is actually quite poor,” said Goh at Aberdeen Asset.

Yuan Depreciation

The difference between bid and offer prices for a five-year Chinese company note with the highest credit rating can be as much as 30 basis points, Goh said. By comparison, that gap is one to two basis points for the most-active five-year issues of Chinese government debt, he said.

The weaker yuan over the past few years and more recent rising onshore bond yields are a deal-breaker for now for Korea Investment Management. China’s currency has weakened 7.9 percent over the past two years, though it has rebounded 3.1 percent so far in 2017. The nation’s AAA rated five-year corporate bond yields have climbed 64 basis points to 4.6 percent this year.

In addition, swapping yuan for Korean won can slice about 2.5 percentage points off of the yield, lessening the appeal, said Yunjin Kim, who heads the global fixed-income management team at Korea Investment Management, which oversees about 43 trillion won ($39 billion).

“While it’s become convenient to buy Chinese onshore bonds after bond connect, we don’t see incentives to buy them for a while,” said Kim.

— With assistance by Ruth Liew, Kyungji Cho, Judy Chen, and Denise Wee

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