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Think diversification, think China bonds

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Although volatility will remain elevated due to market uncertainties, there are a few reasons to believe China will stand out compared to other developed markets.

With supportive statements from top authorities, we believe liquidity will likely remain ample in China and monetary policy is likely to stay accommodative to support credit and investment growth needed for a sustained GDP recovery.

China’s inflation is expected to remain benign relative to US / Europe, leaving room for monetary policy to remain accommodative. Liquidity easing efforts are under way and the People’s Bank of China (“PBOC”) is increasingly moving towards credit easing.

We also expect expansionary fiscal policy that should in turn support China credit, especially in strategically important sectors in the coming months. There has also been easing measures in the China property market, including mortgage rate cuts, and support for bond issuances for top private-owned enterprise developers.

As China gradually opens up from lockdowns, we expect investor sentiment to improve in the second half.

The divergence in policy between China and other developed markets should drive difference in financial markets performance, allowing investors to build portfolios which are fundamentally less correlated to drive diversification benefits.

Diversify with China bonds

For investors who are still cautious about investing in the world’s second largest economy, here are two ways how adding China bonds to your global portfolio can provide diversification and resilience.

Firstly, investing in China is not about market access, but about using China as a building block to create a diversified fixed income solution that optimises yield while managing volatility. Despite being a single-country exposure asset class, CNY credit has seen positive performance and outperformed other key global asset classes across recent periods of major global market shocks.

Onshore China credit showed resilience during periods of global market shocks1

Secondly, the low correlation between onshore CNY and offshore China USD credit market may help investors to diversify to reduce portfolio volatilities and generate alpha through dynamic asset allocation. The onshore market is driven by onshore monetary policy, whereas the offshore market is affected by global risk sentiment and Fed policies that is beyond just China risk factors.

Low correlation between onshore CNY bonds and offshore USD Chinese credit2

Compared to US and EU investment grade credit, we believe China bonds still offer attractive yields at low duration, especially with a strategy that can invest dynamically between onshore and offshore markets to tap into those opportunities.

Therefore, creating a fixed income solution that goes across both the onshore and offshore markets may help us to maximize yields while lowering volatility to deliver attractive risk-adjusted income.

Where we invest

Currently, we maintain a balanced view between the onshore and offshore markets. Onshore markets continue to serve as an important building block to diversify risks in the offshore markets and being able to dynamically invest across both markets in a timely manner drives the success in managing a China Bond portfolio. We are staying up in quality with a shorter duration stance; together with a balanced exposure across both the onshore and offshore markets, this allows us to optimize for high income while keeping expected volatility low.

We are constructive on the onshore market being supported by accommodative monetary policy. The stepping up of macro policy support should steadily feed through to the real economy, especially in infrastructure credits. We like strategically important sectors such as water, utility and other infrastructure-related sectors which will likely benefit from the expansionary fiscal push.

In particular, we see the onshore CNY credit market as a risk-off market, and this was evident during the trade war tension in 2018, the outbreak of the pandemic in 2020, and the YTD sell-off on the back of global inflationary pressures and growth headwinds. Our onshore allocation delivered positive returns during those periods.

In the offshore market, we prefer shorter-dated investment grade credit which allows us to minimize market beta amidst elevated market volatility while capturing attractive income considering current valuations.


Important information:

1 The figures shown relate to past performance. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy. Add-Indices are unmanaged and one cannot invest directly in an index. Downside Mitigation cannot fully eliminate the risk of investment loss. Source: BlackRock, Bloomberg, 29 July 2022. Onshore China Credit Bonds: ChinaBond Credit Bond Index. Asian High Yield (HY): JACI HY Index. Global Investment Grade (IG): BBG Global Aggregate Corporate Total Return Index. Global HY: Bloomberg Global HY Corporate Total Return Index. Emerging Markets (EM) Corp Credit: JPM CEMBI. Time periods for the respective events are as follows – 2018 Q4 trade tension: 30 Sep 2018 to 31 Dec 2018; 2020 pandemic: 31 Dec 2019 to 31 March 2020; 2021 China property tightening: 1 Sep 2021 to 29 July 2022; 2022 Developed market tightening and geopolitical tension: 31 Dec 2021 to 29 July 2022.

2 The figures shown relate to past performance. Past Performance is not a reliable indicator of current or future result. Indexes are unmanaged and one cannot invest directly in an index. Diversification and asset allocation may not fully protect you from market risk. Index performance returns do not reflect any management fees, transaction costs or expenses. Source: BlackRock, data as of 29 July 2022 | USD Chinese Bond: JP Morgan Asia Credit Index – China (CNH hedged) | Onshore RMB Credit: China Bond Credit Bond Index.

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