Fund managers have profited from a popular trade made via Hong Kong’s cross-border investment link to the Chinese mainland’s huge $ 15 trillion bond market, taking advantage of the higher interest rates on onshore bonds compared to their offshore equivalents.
The deal, conducted through the Bond Connect scheme, has been popular with executives active in China’s domestic bonds as well as so-called dim sum bonds – those issued in offshore yuan in Hong Kong. That comes when the Chinese bond market pulls a record in foreign investment, executives and bankers say.
In January alone, the onshore market recorded a net inflow of 120 billion yuan ($ 18.6 billion) from foreign investors, up from an average of 70 to 80 billion yuan per share. Month last year, according to bankers. Some of this influx has been channeled through the Bond Connect mechanism, which enables leaders sitting in Hong Kong to access both markets with ease.
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Investors monitoring the two markets are making a profit by selling their dim sum bonds issued by the Chinese government and then using the proceeds to buy the higher-return onshore equivalent via the Bond Connect link, executives say.
China’s central bank (pictured) and Hong Kong’s de facto central bank are working to expand Bond Connect. Photo: EPA-EFE alt = China’s central bank (pictured) and Hong Kong’s de facto central bank are working to expand Bond Connect. Photo: EPA-EFE
The opportunity arises as a result of dim sum government bonds. The limited size of the market – only $ 9.5 billion in new issues last year – often means that demand for these bonds exceeds their supply. This is comparable to the much larger onshore bond market, where the new issue last year was 48.5 trillion yuan (US $ 7.5 trillion), according to data from Refinitive and the People’s Bank of China.
Also, “some investors expect that the People’s Bank of China will gradually begin to tighten monetary conditions, especially at times when positive Chinese economic data are published,” said Ming Le, associate director of fixed income at HSBC Global Asset Management.
“The liquid onshore bond market is more reactive to these positive economic signals than offshore and sends onshore yields higher.”
The interest rate differential is particularly evident in debt with longer maturities. The average Chinese government bond yield in the dim sum bond market was 2.7 percent after yields on 10-year notes fell more than 20 basis points last year.
This compares with the 3.3 percent paid by onshore bond equivalents. A bond yield moves the other way around at its price.
The deal only makes sense for government bonds because China’s Treasury is an active bond issuer in both the onshore and dim sum bond markets, said David Yim, regional head of the capital markets for Greater China and North Asia at Standard Chartered. Chinese companies do not tend to sell bonds as often.
When investors weigh the yields on government bonds, it is also an equal comparison of the two markets’ interest rates, and credit risks will be considered very distant for Chinese government issuers, Yim said.
“Investors will be hard pressed to do the same comparison for corporate bonds, because they also have to consider whether the market is liquid enough for a possible exit if the company’s financial health e.g. suddenly worsens, ”he said.
Attractive Chinese government bond yields compared to other government bonds attract foreign investors. Photo: alt = Attractive Chinese government yields compared to other government bonds attract foreign investors. Photo:
Foreign investors who own only 2 per cent. Of China’s onshore bond market, Chinese government bonds will continue to pile up due to their attractive yields against US government bonds of 1.35 per cent. For 10-year banknotes or the negative interest rate German bottom.
“Chinese government bonds are a great place for investors now,” said George Sun, head of global markets for Greater China in GDP Paribas, and this will continue to give rise to interest in both the onshore and dim sum markets.
Since its launch in 2017, Bond Connect has only supported the so-called northbound channel, which gives foreign investors access to the Chinese mainland market via Hong Kong. But this is changing, as the central banks of Hong Kong and China have said will start the southbound direction legs this year.
“Some foreign investors still prefer to access the market through Bond Connect, as they prefer faster set-up and the dominant jurisdiction of the Hong Kong court, given that their custodians and trading platform remain in Hong Kong,” Sun said.
This article was originally beaded in South China Morning Post (SCMP), the most authoritative voice report on China and Asia for more than a century. For more SCMP stories, please see SCMP s or visit the SCMPs Facebook and Twitter pages. Copyright © 2021 South China Morning Post Publishers Ltd. All rights reserved.
Copyright (c) 2021. South China Morning Post Publishers Ltd. All rights reserved.