We were asked a question about Chinese government bonds yesterday. Here is the SSC take on them.
Government debt has been weakening as there were three domestic defaults of late, two of which were government related, but a yield of 3.3% appears appealing given yields elsewhere. However, the Chinese economy is doing rather well and forecast to be one of the better performers over coming quarters so yields could rise but we do expect the currency to be a good long term performer and a good position to have on board.
A lot of investors are looking at local Chinese debt markets; we have always said that the only issuers that international investors should consider should be the central government issuance and if absolutely necessary the policy banks too. All other credits should be avoided as it is very difficult to figure out which credits will be supported and which will not. More importantly, if investors have exposure to RMB denominated assets then the major driver of returns is the exchange rate; why try and get an extra few basis points in return from holding non-government issues when the renminbi may appreciate significantly.
The main question is why hold RMB denominated debt in the first place when it’s sub-optimal to do so. Owning US dollar Treasuries at 10 years yield 0.85% and if you hedge into Renminbi, CNH, you currently pick up 2.5% per annum so a total yield of 3.3% same as China governments but with the US Federal Reserve backing you as a buyer. If like us you buy the likes of Middle East AA rated sovereign issuance and then overlay with CNH you get a high quality investment grade bonds at a yield of around 2.5% and a 5% yield with the currency overlay, with potential for capital gains on the bonds, whereas 10 year Chinese government bonds yield 3.3% and limited potential gains in fact yields could rise further as indeed they have been.
There are risks in China, as there are in the US and around the globe in the current climate, but there is no need for investors to expose themselves to those risks if the primary driver of returns is in fact the currency rather than anything else. Again on our funds where permitted we do have open CNH exposure, through the forex forward market, buying CNH forward the carry is built into the price of the forex contract and currently at a one month maturity yields 2.5% on an annual basis.
As we mentioned yesterday we run an award winning strategy with an overlay of the Chinese yuan.