Yield-hungry Japanese investors flocking to Chinese bonds
The attraction of China’s higher-yielding bonds and improved access is enticing Japanese investors, many of whom are slowly adding the mainland’s debt markets to their pool of mainstream investment options.
While the amounts they have invested so far make China a modest investment at best for the yen-based investors, they have already plowed a record amount into yuan bonds this year.
Japanese investors, famed for pumping billions of dollars into high-yielding markets across the world, have been long wary of Beijing’s controlled and closed markets.
But China’s rapid market reforms, relatively high yields and the prospects of yuan bonds being included in major bond benchmarks have lured Japanese to the $12 trillion market that looks set to overtake their own as the world’s second-largest.
“A growing number of investors are interested in Chinese bonds now,” said Hiroshi Yokotani, portfolio strategist at State Street Global Advisors. “The biggest attraction is their relatively high yield.”
Ten-year Chinese government bonds currently yield about 3.65 percent CN10YT=RR, compared with about 3.08 percent on 10-year U.S. Treasuries US10YT=RR and 0.83 percent on French government bonds FR10YT=RR, the latter another favored Japanese investment.
Data from Japan’s Ministry of Finance showed Japanese investors have bought 151 billion yen ($1.33 billion) of Chinese bonds so far this year.
That far exceeds the record 83 billion yen they invested in 2016, when Japan’s introduction of a yield curve control policy sent domestic investors scurrying for better returns in foreign markets.
Chinese government bonds are rated single-A by international rating firms, lower than triple-A for their U.S. and French peers, but on par with Japanese government debt.
Any concerns investors may have had about the impact of the U.S.-Sino trade war on China’s economy have been allayed by Beijing’s push to ease monetary and fiscal policy.
One trigger for a spike in interest is the Bond Connect scheme China introduced last year, which allows foreign investors to invest in Chinese bonds through Hong Kong.
Dai-ichi Life Insurance (8750.T), one of Japan’s biggest insurers, started investing in Chinese bonds using the scheme, said Koichi Matsumoto, general manager of global fixed income investment.
“China’s policy stance on markets is becoming very open, which we take very positively. And the speed of their market reforms is quite fast, compared to other countries,” said Matsumoto.
In August, the Connect program began real-time delivery-versus-payment (DVP), which sharply reduces settlement risks.
Adding to the allure of Chinese bonds, Beijing is temporarily eliminating taxes for foreign institutions looking to invest in the country’s corporate bond market.
Some investors are also trying to enter the market ahead of the planned inclusion of China into a major international bond benchmark provided by Barclays and Bloomberg.
To sate retail appetite, UBS Asset Management and Okasan Asset Management have launched China bond funds in recent months.
Japanese investment in yuan bonds is still a fraction of their overall overseas flows, however.
As of December 2017, these investors held just 234 billion yen of yuan bonds, compared to holdings of 138.2 trillion yen in U.S. dollar assets and 50.9 trillion yen in the euro.
One factor holding back institutional investors is access to yuan funds in China’s relatively young money markets.
“We want to expand investments in Chinese bonds as the market size grows. But while we have lots of yen, we need to be mindful of funding in foreign currencies,” said Yasuhiko Sugimoto, general manager of international treasury at Mizuho Bank. “For us, it is vital to have a liquid repo market.”
Another problem for Japanese investors is that Japan’s near-zero yields make it often prohibitively expensive for investors to hedge their overseas exposures.
A fully hedged Chinese bond investment would help yen holders diversify their portfolios but the return would be close to nothing.