Renminbi Bond Fund -
Ten Years On

Launched almost 10 years ago, taking renminbi exposure through the Renminbi Bond Fund remains one of Stratton Street’s most compelling investment themes. Over the past decade returns have been extremely strong with an annualised return of 9.1%, net of fees in US dollar terms, which spans the financial crisis in 2008 when the fund returned +5.6%.


Renminbi Bond Composite performance chart (gross)

 Composites are internally calculated returns based on Stratton Street’s own branded funds and institutional accounts. All comparisons for all funds are based on Nov-2007 launch of Stratton Street Renminbi Bond Fund Strategy. Source: Bloomberg and Stratton Street calculations. All returns are calculated gross of fees and include dividends re-invested, data as at end Sep-2017.  Past performance is not a reliable indicator of future performance.

Composites are internally calculated returns based on Stratton Street’s own branded funds and institutional accounts. All comparisons for all funds are based on Nov-2007 launch of Stratton Street Renminbi Bond Fund Strategy. Source: Bloomberg and Stratton Street calculations. All returns are calculated gross of fees and include dividends re-invested, data as at end Sep-2017.  Past performance is not a reliable indicator of future performance.

Why do we think the fund is so compelling?

It is compelling from a NFA perspective.  We define net foreign assets (NFA) as:

Net Foreign Assets (NFA) = Cumulative Current Account (CA) + Valuation effects (VE)

This methodology captures the build-up of assets or liabilities not just of the government, but also the debt or asset accumulation of corporates, banks and individuals. Consequently, the concept of net foreign assets measures the aggregate savings or borrowings of the entire country, not just government debt. Countries that save more than they invest run current surpluses and vice versa.

Andy Seaman, in his paper ‘Does Lending to debtors make sense for bond investors?’ (2013), demonstrated the importance of NFA analysis as a long-term driver of currency and bond returns.  His theoretical framework suggests that the performance of bonds and currencies of debtors and creditors varies according to whether the world is experiencing a period of reflationary financial market conditions, where capital flows from creditors to debtors, or whether we are in deleveraging phase with capital flowing in the opposite direction. As capital flows from the creditor countries this should be associated with a depreciation of their exchange rates with a corresponding rise in the exchange rates of the debtors.

Stratton Street’s view is we are in a deflationary period of the cycle as central banks start to remove policy accommodation and QE is scaled back.  Thus, from a portfolio positioning point of view this favours creditor nations: China is a creditor nation and we retain a positive view of the renminbi.
 

The chart below shows how currency shifts support NFA analysis:

 Source: (FX) Bloomberg from RBF inception (end Nov-2007) to end Sep-2017, (NFA) Stratton Street Capital LLP calculations (2011) and extended version of the External Wealth of Nations Mark II database developed by Lane and Milesi-Ferretti (2007)     

Source: (FX) Bloomberg from RBF inception (end Nov-2007) to end Sep-2017, (NFA) Stratton Street Capital LLP calculations (2011) and extended version of the External Wealth of Nations Mark II database developed by Lane and Milesi-Ferretti (2007)     

The chart above shows the spot return versus the dollar with each country’s NFA position. The fact that the top four performing currencies are all creditors lends weight to the argument that NFA is an important long term driver of currencies. It is also no surprise to us either that the renminbi tops the table in terms of performance being a creditor nation and this is even without factoring in the positive carry. We continue to expect China to run a persistent, albeit smaller (2-3% of GDP) current account surplus and expect this trend to continue and its domestic goal of boosting consumption is best achieved with a stronger exchange rate.

Other factors influencing currencies include growth, inflation and interest rates: these all look supportive from a renminbi perspective.  Plus, on an income adjusted purchasing power parity basis the renminbi is 10% undervalued (Big Mac data).
 

Opportune timing: renminbi should strengthen as dollar peaks

China has managed its currency against a basket of trade weighted partners since the currency was unpegged in 2005. The basket comprises of 22.4% US dollars, 16.3% EUR, 11.5% JPY, 10.8% KRW with the balance in a range of currencies. The renminbi fluctuates in a band, currently 2%, around the basket.

CFETS RMB Index Weighting

 Source: Reuters: Sep-17

Source: Reuters: Sep-17

Positive carry enhances currency returns

The portfolio is currently 100% exposed to the renminbi through the foreign exchange market using either the Chinese onshore currency known as CNY or the offshore currency CNH. Currently we are 100% exposed through CNH but the mix can vary. Going forward, it may also vary if we bought CNY bonds directly as bond-connect has made the process much simpler and provides access to some liquid names. Chinese rates are higher than US rates so we are paid to buy and own the renminbi forward – the amount fluctuates with interest rate movements. For the year to the end of September 2017 the carry has added 3.47% to the spot return of 4.95% for a total return of 8.42% against the US dollar.

Overseas investors are underweight China

International investors hold less than 2% of the Chinese bond market, which is far too low given the importance of the Chinese economy and the scale of the bond market. The Chinese bond market at USD 10tn is the third largest global bond market after the US and Japan. The launch of “Bond Connect” in Hong Kong is likely to increase the likelihood of inclusion in the major bond indices. This will lead to significant inflows from passive fixed income investors. 

Returns maximised through selecting undervalued Eurobonds

Using our proprietary NFA screen and relative valuation model (RVM) we select Asian bonds that trade several credit notches cheap versus our models offering additional upside were they to trade at fair value. At the moment the portfolio (based on the AIF as of 30 September 2017) is trading around 4 notches ‘cheap’ with a gross redemption yield of 4.1% and a weighted rating of A. We continue to favour positioning at the long end on a duration weighted basis as we expect the Fed to remain ‘ahead of the curve’. By hedging into renminbi we gain the same currency exposure as a pure renminbi investment but with a significantly higher yield, broader investment opportunities and greater liquidity. Currently the average issue size stands at over USD 1 billion. 

Significant outperformance against the peer group

Since the launch of many newer renminbi bond funds in mid-2011, Stratton Street’s Renminbi Bond Fund has outperformed significantly.

 The Renminbi Bond Fund (USD Class-A) was launched at USD100 on end Nov-07, all comparisons include dividends reinvested, net of fees, data end Aug-11 to end Sep-2017. Source: Bloomberg, Stratton Street Capital LLP calculations. Past performance is not a reliable indicator of future performance.  

The Renminbi Bond Fund (USD Class-A) was launched at USD100 on end Nov-07, all comparisons include dividends reinvested, net of fees, data end Aug-11 to end Sep-2017. Source: Bloomberg, Stratton Street Capital LLP calculations. Past performance is not a reliable indicator of future performance.
 

The fund has been available in AIF (Guernsey PCC) since 2007 and in UCITS (Luxembourg) since 2013. Further details available upon request.

Click here to contact us 

Click here for full report - PDF version

 

Please read this important information before proceeding. It contains legal and regulatory notices relevant to the information on this site.

This website provides information about Stratton Street Capital LLP ("Stratton Street"). Stratton Street is authorised and regulated by the UK's Financial Conduct Authority. The content of this website has been prepared by Stratton Street from its records and is believed to be accurate but we do not accept any liability or responsibility in respect of the information of any views expressed herein. The information, material and content provided in the pages of this website may be changed at any time by us. Information on this website may be out of date and may not be updated or removed.

The website is provided for the main purpose of providing generic information on Stratton Street and on our investment philosophy for the use of financial professionals in the United Kingdom that qualify as Professional Clients or Eligible Counterparties under the rules of the United Kingdom Financial Conduct Authority (the "FCA"). The information in this website is not intended for the use of and should not be relied on by any person who would qualify as a Retail Client. Products and services referred to on this website are offered only at times when, and in jurisdictions where, they may be lawfully offered. The information on this website is not directed to any person in the United States. The provision of the information on this website does not constitute an offer to purchase securities to any person in the United States (other than a professional fiduciary acting for the account of a non-U.S person) or to any U.S. person as such term is defined under the Securities Act of 1933, as amended.

The website is not intended to offer investors the opportunity to invest in any Alternative Investment Fund ("AIF") product. The AIFs managed by Stratton Street are not being marketed in the European Economic Area ("EEA") and any eligible potential investor from the EEA who wishes to obtain information on the AIFs will only be provided with materials upon receipt by Stratton Street of an appropriate reverse solicitation request in accordance with the requirements of the EU Alternative Investment Fund Managers Directive ("AIFMD") and national law in their home jurisdiction. By proceeding you confirm that you are not accessing this website in the context of a potential investment by an EEA investor in the AIFs managed by Stratton Street and that you have read, understood and agree to these terms.

No information contained in this website should be deemed to constitute the provision of financial, investment or other professional advice in any way. The website should not be relied upon as including sufficient information to support any investment decision. If you are in doubt as to the appropriate course of action we recommend that you consult your own independent financial adviser, stockbroker, solicitor, accountant or other professional adviser. Past performance is not necessarily a guide to the future. The value of investments and the income from them may go down as well as up. An application for any investment or service referred to on this site may only be made on the basis of the offer document, key features, prospectus or other applicable terms relating to the specific investment or service.

Where we provide hypertext links to other locations on the Internet, we do so for information purposes only. We are not responsible for the content of any other websites or pages linked to or linking to this website. We have not verified the content of any such websites. Such websites may contain products and services that are not authorised in your jurisdiction. Following links to any other websites or pages shall be at your own risk and we shall not be responsible or liable for any damages or in other way in connection with linking.

By using this site, you should be aware that we may disclose any information that we hold about you to any regulatory authority to which we are subject, or to any person legally empowered to require such information.

This website uses cookies to improve user experience, by clicking the "I Accept" button below means you consent to the use of cookies on our website.