The competition across Asia to keep currencies weak will benefit renminbi-denominated bonds as wealth-preserving investment options become increasingly scarce, according to Bank of China (Hong Kong) Asset Management (BOCHK AM).
The short-term weakening of the Japanese yen will put pressure on several export-driven countries in Asia such as Korea, Malaysia, Singapore and Taiwan, to depreciate their own currencies, said Ken Hu, chief investment officer for fixed income at BOCHK AM.
“The renminbi will not follow this trend for two good reasons. One is that net exports only account for a small part of China’s GDP, around 3%. China has transformed its economic growth model – three years ago net exports accounted for more than 10% of China’s GDP. The second thing is that the economic growth model of China has transformed into a domestic driven one.”
This shift will be reinforced by China’s new leadership. In contrast to other Asian countries, China will increasingly rely less on exports, and the renminbi will not be caught up in Asia’s attempts at reflation.
“I just returned from Taiwan, where ordinary investors are seeing the renminbi as a better tool of wealth storage, as the Taiwanese dollar is likely to join the currency wars and they see the [CNH] as a better alternative,” said Hu.
In February, Taiwan became another offshore renminbi centre, and investors in the country are taking full advantage of the change, he said.
“The 10-year government bonds in Taiwanese dollars only give investors a yield of around 1.1%. If they shift from Taiwan government bonds to, let’s say, CNH Chinese government bonds, they can more than double the yields.”
In addition, the renminbi will likely remain stable or appreciate against the US dollar, offering an additional bonus to bondholders.
Germany
“Also I just returned from a business trip to Germany, and there is huge demand for renminbi bonds. They tend to be more conservative in terms of the credit risk, with a focus on investment grade.”
The yield advantage is a plus and German investors also prefer to buy CNH bonds with a euro-hedged share class in order to take advantage of the long-term appreciation trend of the renminbi versus the dollar, without taking on euro currency risk, he said.
“They are seeing renminbi bonds as a new market, it has a lot of diversification benefits for their bond portfolio, as the renminbi has a very low correlation with the other asset classes. There are no official statistics but we have been seeing continuous money inflows into the fund.”
BOCHK AM has a Luxembourg-based fund in Europe partnered with Sal. Oppenheim, a German private bank, which was bought by Deutsche Bank in 2010. SOP AnleihenChinaPlus is an Asian fixed-income fund which focuses on China.
“We are now talking to other potential partners in other European countries, and may launch more strategic partnerships in the future. Our general feedback from the other countries is good and they share our idea that the renminbi is a new asset class,” said Hu.
“To some it is a new tool of wealth storage, as these are getting harder and harder to find. You can buy gold, but gold will not give you interest rates, whereas the renminbi will give you rates of more than 3%. Australia may be another country where you can still find interest rates of above 3%.”
Risks
He pointed out that there are still concerns among German investors, particularly as the dim sum market is so new, but argues that asset allocation will increase as the offshore renminbi bond market grows.
“I suspect there will be rising supply and also rising demand. The supply will come from both mainland Chinese companies as well as from around the world. The offshore renminbi bond market is more like the Eurodollar bond market around a decade ago, not another emerging market local currency market.”
He remains overweight Chinese corporate bonds – the BOCHK RMB Fixed Income fund allocates 54.1% to corporates, including financial services.
However, he said that the lack of international credit ratings on some of the bonds is increasingly a problem, as many global investors from Taiwan as well as from Europe require a rating from at least one of the three global agencies.
Another possible issue is the concentration risk from certain sectors, such as Chinese property, but he believes this can be circumvented by careful bottom-up analysis.
“Company selection is key to really differentiate lemons from cherries. But from a top-down perspective, for the next few years the urbanisation of China will continue to be good for this sector. From time-to-time we may see some anti-speculation policies to be launched, which may cause negative equity stories, but in the long run, they still need property developers to build houses,” he said.
“After all 49% of China’s population is still living in rural areas with very poor living standards and every year millions of farmers are migrating from their villages into cities. So China does need to have more houses and more apartments, but we need to be careful when selecting the property developers that issue bonds.”
Another possible pitfall is bond covenants, which are becoming looser as more Chinese names tap the international market.
“I have become more careful on checking the bond covenants, in particular the covenant that limits the leverage level of the company, that is important,” he said.