Holding Chinese debt is an alluring proposition for money managers looking for fresh hedges to counterbalance to their riskier stock holdings, a bedrock of the ubiquitous 60/40 portfolio. It also comes as investors begin to ask serious questions about the plumbing of the Treasury market amid the recent volatility.
"Treasuries' role as a safe haven is not there anymore," said Tracy Chen, a Philadelphia-based portfolio manager at Brandywine Global, who bought Chinese debt for the first time last year. "There is an increasing possibility of using China bonds as an alternative."
Chinese bonds' correlation with peers during last month's rout was close to zero
China was the first major economy to emerge from the pandemic. As a result, yields there had already risen to levels last seen before the crisis, something bond investors in the rest of the world are only beginning to grapple with. At 3.25%, the yield on China's 10-year bond now towers over its major peers.
Investors are taking notice. Chinese bonds funds saw $420 million of inflows in the week through March 10, even as investors lowered their emerging-market holdings by the most in nearly a year, according to EPFR Global. They haven't seen outflows in about 10 months.
Foreign investors bought 93.6 billion yuan ($14.4 billion) worth of Chinese debt in February, after adding positions at a record pace the previous month, egged on by the addition of China's government and policy-bank bonds into the world's major indexes in 2019.
"From a relative value perspective, all stars are aligned," said Jean-Charles Sambor, head of emerging-market debt at BNP Paribas Asset Management in London who is overweight Chinese debt. "We're likely to see rotation not only from low yielders in emerging markets but also from global markets into China."
Still, there are plenty of risks that can throw a wrench into the trade. China is looking to curb a rapid buildup in financial leverage, which means the central bank may guide borrowing costs higher. The debt market has long been criticized for its poor liquidity since local lenders hold the majority of bonds and don't actively trade them.
On March 5, a normally dull Chinese policy-bank bond surged more than 200%, sending the yield to -14% by the close. Though the move was erased Monday, concern over what happened will linger.
"China has a lot of work to do in terms of boosting liquidity for investors and build some financial infrastructure to enable people to do futures," said Brandywine Global's Ms. Chen.