The Daily Update - Further China government bond inclusion

This week Citigroup Inc announced that China’s onshore bonds will be included in three of its government bond indexes from February 1 2018. This news follows the announcement last month from the Bloomberg Barclays Fixed Income Indices of new parallel global indices which include China renminbi (RMB) denominated securities. The assets under management for funds tracking Citi’s indices may be relatively small, however, the new weights will surprise many investors who have neither been following the RMB internationalisation story nor are aware of the scale of the Chinese bond market. According to Citibank, the weight of China in their existing Emerging Markets Government Bond Index will rise from zero to a huge 52.5%.

Once included, the scale of shift towards Chinese government bonds may be modest initially, however the direction is very clear. Unless funds following these indices increase overall, there will be a shift away from the existing components in favour of China. At Stratton Street we use net foreign assets as a measure of a country’s overall assets or liabilities; China ranks well on this measure being a net creditor nation. In contrast, Brazil for example is a major debtor. As investors rebalance, which may take time, there will be a natural shift away from debtors to creditors which has important implications for correcting global imbalances were the reallocation to become more widespread.

We are not currently invested in the onshore bond market, only because our preferred strategy of buying investment grade liquid dollar bonds and hedging into CNH, across our Renminbi Bond strategy, is very profitable for us at the moment. It doesn’t mean that we don’t think onshore bonds are attractive, we just have a preference to invest elsewhere. For example, the one-month CNH forwards are priced to give an implied annualised yield of around 7% (the 45-day yields as much as 8.7%!), which is way above anything that can be achieved in local markets for similar credit quality.

Most investors, even some of the largest firms in the world, do not even have a cash position in RMB. Were these investors more forward thinking, they would realise that China’s offshore and onshore bond markets present an opportunity, and those holding RMB assets now are likely to outperform those who follow later. It may take time for investors to acknowledge that the world is changing, but it is inevitable that investors will hold more RMB in the future than they do today.

Although the widely held opinion is that the RMB is relatively weak, we disagree that notion. Weak relative to what? True, over the past 12 months the RMB has declined against the dollar and many other emerging currencies, but over the last three years the only major currency to outperform the RMB has been the Japanese yen, which gained ~1.5% against the redback.

Our assessment is that investors have a false perception of the relative strength of the RMB and consequently think the bond market is unattractive. It’s a big perception problem for China, which is largely due to international investors and press outlets misunderstanding the comments from Chinese officials. China has an incentive for a stable or stronger RMB and that message has been unheeded by international investors. Maybe China needs to adopt a strong RMB policy like the US which supposedly has a strong dollar policy to change investor perception.

If we are right about the future for the RMB, a world in which countries like China with large current account surpluses see their currencies appreciate, then investors in indices without RMB will likely underperform those that follow indices which include the Chinese currency. Consequently, RMB strength will likely lead to a shift in the preference of fund managers who will want to track the better performing indices rather than the outdated versions that exclude the currency of the world’s second largest economy.

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.