Nov 27, 2023
China is normally a strong portfolio diversifier, but 2023 was different. Like other global fixed income markets, Chinese fixed income had a very challenging year, and this was the result of domestic economic pressures. But outcomes across this diverse investment universe have not been uniform.
Onshore Chinese government bond yields have been remarkably resilient. Faced with positive yields – in contrast with some major developed-market peers – China’s policymakers were able to cut rates and add additional support to the economy (on top of fiscal loosening), and this helped bond prices.
In the onshore credit market, debt issued by state-owned enterprises (SOEs) performed well, but debt issued by private companies came under pressure, particularly in the real-estate sector given the ongoing challenges there.
A similar bifurcation was seen in the offshore US dollar bond market, with SOE debt generally performing well but real-estate sector bonds struggling.
Although nowhere near the double-digit growth rates seen in years gone by, the world’s second-largest economy is still growing at a much healthier pace than much of the developed world. But perceptions in the market have swung from overly optimistic to depressingly downbeat. There is a clear disconnect between the narrative among the international investment community and what’s happening on the ground. This is resulting in some heavily discounted valuations in parts of the asset class that active investors can look to take advantage of.
Gradual policy easing is happening – reflecting a cautious approach and pursuit of a sustainable growth path. Yet frustration among many market participants reflects unrealistic expectations, in our view. We will not see huge and costly stimulus programmes in China like those rolled out in many developed economies in response to COVID (and other crises). Investors should expect China’s policymakers to continue seeking to stabilise growth at a lower level as opposed to returning it to its prior trajectory; a longer-term mindset is required.
While shifts have taken place as countries like the US increasingly focus on their geopolitical allies for trade flows, China is still ultimately benefitting from global export trends. China is investing in the likes of Vietnam, the Philippines, Indonesia and Mexico, which are starting to produce intermediate inputs for Chinese exports, but with a large part of the upstream and downstream supply chains still originating in China. While this is likely to grow in complexity, we think the general trend will ultimately support the further development of fixed income in Asia, given the investment and funding needed for these initiatives.
Structurally, China remains an important destination for investors seeking a balanced portfolio, given its sheer size and importance in global trade and global supply chains. Cyclically, it is a challenging time, but it is starting to feel like the worst is largely behind us, although with so much uncertainty and the inherent unpredictability of geopolitical and geo-economic considerations, patience is key.
While short-term currency pressure is likely to remain, with China’s growth supported by policy and re-opening activity and its export mix moving quickly up the value chain, the medium-term outlook for the renminbi remains constructive. Current valuations and high trade surpluses support its long-term value.
We think an uneven growth recovery and muted inflation will keep Chinese monetary policy supportive for yields. The onshore Chinese yuan (CNY) bond market should continue to reflect domestic dynamics, making it a useful portfolio diversifier.
At current valuations, select segments of the offshore US dollar bond market provide a good yield opportunity; meanwhile, we think that distressed real-estate sector bond valuations do not accurately reflect ultimate recoveries.
General risks. All investments carry the risk of capital loss. The value of investments, and any income generated from them, can fall as well as rise and will be affected by changes in interest rates, currency fluctuations, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which the investment strategy invests. If any currency differs from the investor’s home currency, returns may increase or decrease as a result of currency fluctuations. Past performance is not a reliable indicator of future results. Environmental, social or governance related risk events or factors, if they occur, could cause a negative impact on the value of investments.
Specific risks. Geographic/Sector: Investments may be primarily concentrated in specific countries, geographical regions and/or industry sectors. This may mean that, in certain market conditions, the value of the portfolio may decrease whilst more broadly-invested portfolios might grow. Currency exchange: Changes in the relative values of different currencies may adversely affect the value of investments and any related income. Default: There is a risk that the issuers of fixed income investments (e.g. bonds) may not be able to meet interest payments nor repay the money they have borrowed. The worse the credit quality of the issuer, the greater the risk of default and therefore investment loss. Derivatives: The use of derivatives may increase overall risk by magnifying the effect of both gains and losses leading to large changes in value and potentially large financial loss. A counterparty to a derivative transaction may fail to meet its obligations which may also lead to a financial loss. Interest rate: The value of fixed income investments (e.g. bonds) tends to decrease when interest rates rise. Emerging market (inc. China): These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems.