Emerald Yau, head of equity index product management, Asia
As China’s recovery from the coronavirus-induced slowdown gathers strength,[1] the country’s capital markets are proving to be an attractive venue for global investors seeking to generate reasonable returns while safely diversifying their portfolios in a tough business environment.[2]
Let’s look at the numbers first, which underline the strength of the broad-based resurgence in the Chinese economy while the rest of the world is struggling to cope with the pandemic. Year-over-year GDP growth sped up to 4.9% in the September quarter compared to 3.2% in the previous quarter while retail spending has bounced back to pre-pandemic levels.[3]
The country’s bellwether manufacturing sector has also regained its footing. In September, industrial production year-over-year growth recovered to 6.9% from -13.5% in February, when COVID-19 cases were rising rapidly across China.[4]
Greater diversity, better risk-adjusted returns
China offers a deep pool of investment opportunities across onshore and offshore markets. However, due to previously tight restrictions on foreign investor access to the onshore capital market, Chinese assets have remained relatively underexplored by global investors, with only around 4% of China A-shares and less than 3% of onshore bonds currently held by foreign investors.
In terms of equities, China offers exposure to a range of old economy and fast-growing new economy sectors as the country undergoes a transformation toward a consumption-driven growth model. Consider this: China has the world’s second largest single-country equity market with a total onshore market capitalization of over USD10 trillion.[5] And while foreign investor participation has grown significantly in the past few years as regulations governing onshore market access have been relaxed—at a CAGR of 35% over the past 6.5 years—Chinese stocks continue to be underrepresented in most portfolios.[3]
The Chinese yuan too has largely remained resilient over the course of the pandemic and the currency has historically demonstrated lower volatility than other emerging market currencies. Additionally, some central banks around the globe have begun to adopt the yuan as a reserve currency. It is expected by the market that the yuan will account for an increased share of global foreign exchange reserve currency in the coming decade from the current 2% share—a big draw for foreign investors.
The numbers are impressive on the fixed income side as well. China is home to the world’s second-largest bond market, valued at more than USD16 trillion.[1] For investors seeking better yields in a challenging macro and geopolitical environment—where interest rates in the developed market are expected to remain low at least until 2023—China’s onshore bond market offers an attractive alternative. For example, a market comparison from late-October shows 10-year government bonds in China offering a yield of over 3% while similarly dated US Treasuries offered around 0.8%.[2]
The yield enhancement offered by Chinese government bonds is even more notable considering comparable debt in the Eurozone, such as Germany and France, which carry negative yields. Additionally, the spread between yields offered by Chinese government bonds versus those found across key markets has widened in the past six months as yields in such markets dropped further on pandemic-induced economic weakness.
Given their relatively lower correlation to developed markets, Chinese assets are seen offering a significant opportunity for portfolio diversification through a multi-asset investment strategy. This trend is further corroborated by our analysis, which shows that introducing onshore Chinese equity and fixed income assets to a USD-denominated global portfolio improves its overall risk-adjusted return, particularly during volatile times such as over the course of pandemic.
Source: FTSE Russell as of 4th November 2020. “Global gov bonds” represented by FTSE World Government Bond Index (which does not consist any China exposure currently) and “Global equities” represented by FTSE All-World Index (which consists less than 1% in A shares). “” represented by FTSE Chinese Government and Policy Bank Bond Index and “” represented by FTSE China A Index. Analysis based on monthly gross return data in US dollar. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Continually improving market access
Access to China’s capital markets has improved steadily over the years, contributing to its growing appeal, especially following the inclusion of China A Shares and Chinese government bonds into global indexes.
Most recently in November 2020, Chinese policymakers integrated the popular QFII and RQFII programmes into a single ‘qualified foreign investor’ regime to further ease foreign institutional investors’ access to China’s capital markets. FTSE Russell completed its phase 1 inclusion of China A shares into its flagship global and regional indexes earlier this year.
Additionally, China has made significant improvements to its fixed income market infrastructure to expand access to international investors ahead of the inclusion of the country’s sovereign debt instruments into the FTSE World Government Bond Index (WGBI) in October
2021. This is expected to trigger inflows worth USD140 billion over the inclusion period.[9]
Source: CSRC, SAFE, PBOC, FTSE Russell; November 2020
Ultimately, as the global economic outlook remains shrouded in uncertainty due to the pandemic, an analysis of current market trends and data point to the effectiveness of adopting a multi-asset investment strategy to build a more efficient portfolio that can take advantage of the dual benefits of diversification and yield enhancement offered by the fast-growing yet underexplored capital markets of China.
[4] Source: World Health Organisation
[5] World Federation of Exchanges; as of end [September 2020]
[6] National Bureau of Statistics of China
[8] Source: World Government Bonds
[9] Source: Reuters
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