JP Morgan Is Behind The Eight Ball On China Bonds
When will J.P. Morgan discover China’s bond market and include it in their massive Global Emerging Market Government Bond Index, aka the GBI-EM GD. Bloomberg Barclays Global Aggregate Bond Index added some Chinese corporate bonds priced in local currency recently. JPM is behind the eight ball. Don’t be a hater, guys.
Here it is in a nutshell: China’s Frankenstein economy — on part capitalist, one part communist — is opening to capital markets. Its bond market is the third largest in the world, with $13 trillion in outstanding bonds. Its currency is the most stable of any emerging market currency. It pays a bit more in yield than the U.S. and more than anything in Japan. Euro bonds pay maybe 1%. And if you’re worried about bankruptcies and hard landings, keep in mind that the People’s Bank of China is a short-sellers worse nightmare.
The two most influential providers of fixed income benchmark indices for developed economies already consider Chinese bonds sufficiently accessible for inclusion in their indices — Bloomberg and FTSE. JP Morgan is the outlier.
“One is left wondering how this is even possible,” says Jan Dehn, head of research at the Ashmore Group, a $75 billion emerging market bond fund manager based in London. “Does JP Morgan hold (China) to higher standards than FTSE and Bloomberg?”
One reason why bonds from countries like China are not included in indexes is because the market isn’t deep enough. China is not as liquid as Brazil, so that can be one reason why certain Chinese bonds are not in some bond indexes.
Only 19 emerging market countries are included in the GBI EM GD index and only 9% of emerging market local currency government bonds are represented in that index. The rest is dollar or euro-denominated bonds.
BlackRock likes the decision to include China’s local currency government debt in the index and is buying more. Most funds tracking the index will have to make a play on China bonds anyway, especially if they want to meet or beat the index. Passive investors like BlackRock’s iShares exchange traded funds will be equal weight. Active money managers might go underweight, but they will be buyers regardless how heavy they go in.
It’s not that they are being forced to. Global investors have been waiting patiently for China to open its capital markets for years. Now we are getting somewhere.
The Bloomberg Barclays index brings in local-currency government and includes the bonds of top state banks like the Industrial and Commercial Bank of China. Their weighting is set to increase over a 20-month period.
Local-currency Chinese bonds are set to make up roughly 6% of the global fixed income benchmark when the phase-in is complete. At that stage, China’s currency will be the fourth-largest component in the index, behind the U.S. dollar, euro and Japanese yen.
“I’m a China bull. The changes they’ve made to the economy, for an economy their size, is pretty impressive,” says Chris Gaffney, the president of world markets for TIAA Bank. “The renminbi (RMB) is becoming more widely accepted as a currency in trade throughout Asia. I don’t think it surpasses the dollar, but I think it surpasses the (Japanese) yen. I’m not a yen bull. For diversification in fixed income, I would not go to Japan. I wouldn’t want to hold the yen at all. Give me RMB.”
Local-currency Chinese bond yields this decade have been higher than the average yields of the developed market bonds that make up the majority of the global bond index. Japanese yens are basically money in a pillowcase.
Richard Turnill, global chief investment strategist for BlackRock, says that liquidity is definitely a concern.
“Particularly for investors with shorter-term horizons,” he wrote in an April 22 commentary published on BlackRock’s website titled “Emerging Opportunities in China Bonds.”
The domestic Chinese investor traditionally has had a “buy and hold” approach to investing. As more foreign investors come in, and trading picks up between the new bond-connect system between Hong Kong brokerages and the mainland, then liquidity should improve.
J.P. Morgan is likely waiting to see how the new bond connect system works, much like MSCI took a wait-and-see approach in the mainland China equity market when Shanghai and Shenzhen broker/dealers were connected to the more sophisticated Hong Kong-based firms that have long-standing ties with Western investors. The A-shares are now an even larger part of the MSCI China and MSCI Emerging Markets Index.
China is still an opportunity cost many wealth fund managers are willing to take. It doesn’t matter that it’s the world’s No. 2 economy after the U.S. Private wealth offices that build their own portfolios for clients are usually not wedded to benchmarks.
“There’s not enough yield in China to make that kind of investment in unknown securities anyway,” says Luis Maizel, co-founder and senior managing director at LM Capital Group, a $4.5 billion wealth management firm in San Diego. “Why should I take the risk in a Chinese bank’s corporate bond? I know nothing about Chinese banks. I don’t want to make stupid mistakes, so I’ll stay away from China bonds.”