The imminent debut in June of China's $8 trillion A-shares stock market in global benchmark indexes has garnered a lot of attention, but the inclusion of the country's $12 trillion bond market — starting 10 months later — could be far more consequential.
On March 23, Bloomberg Barclays Indices announced it will begin adding Chinese government bonds to its widely tracked Global Aggregate index in April 2019 and achieve a full target weighting of 5.5% by November 2020.
Some industry veterans predict China's admission to that club will effectively be a coming-out party for a market capable of quickly establishing itself as a safe-haven destination for yield-hungry investors around the world.
Over the longer term, they say, Chinese bonds will challenge U.S. Treasuries as the ballast of choice in turbulent times for institutional portfolios.
That's a bold prediction for a market that, outside of a select circle of central banks and sovereign wealth funds, has continued to be shunned by institutional investors as an off-benchmark bet difficult to access or hedge. Most managers peg foreign ownership of Chinese bonds at roughly 2% of the broader mainland market — or a little over $200 billion.
Fans of the market contend the flood of reform in China in recent years has left investors struggling to keep abreast of the opportunities offered now.
The rapid pace of regulatory change has made it challenging for people to "join all the dots together," said Hayden Briscoe, Hong Kong-based managing director and head of Asia-Pacific fixed income with UBS Asset Management.
Offshore investors remain "concerned about their ability to move capital in and out of the country," even as successive reforms in recent years have made it easy to do so, said Luc Froehlich, Singapore-based head of investment directing, Asian fixed income, with Fidelity International. Such concerns were justified in the past but not anymore, he said.
From virtually no entry, investors now enjoy considerable access to one of the largest bond markets in the world, agreed Manu George, a senior managing director, fixed income, with Schroders Investment Management in Singapore. Schroders launched a Hong Kong-domiciled strategy to invest in mainland bonds in December 2014 and a Luxembourg-domiciled strategy in June 2017, which combined now have $140 million in retail assets and $500 million in institutional assets, he said.
Investors desperate for income that the Global Aggregate index — with its heavy weightings in low-yielding Japanese and German government bonds — can't deliver now have been taking on more risk, seeking higher returns from emerging market bonds, Mr. Briscoe noted.
"What we're saying to clients is, 'why don't you think about Chinese government bonds? Firstly because" — with real yields that offer 150 basis points to 200 basis points of pickup over other developed market bonds — "it satisfies the income side," he said. And in terms of defensive characteristics, they act "exactly like U.S. Treasuries — when the S&P sells off, it's negatively correlated," he added.
Mr. Briscoe said the blank stares that suggestion elicited from offshore asset owners five years ago have given way to signs of growing interest — an evolution other managers report as well. Five years ago, "I had to defend the idea" of investing in China, but in the past three years more clients have become receptive — looking for reasons to invest, said Fidelity's Mr. Froehlich. Now a third phase is starting where people seem ready "to pull the trigger," he said.