(BLOOMBERG) – In a world filled with bond investors hungry for safe assets offering attractive yields, Chinese government bonds had become a tempting spectacle in recent years.
However, red flags are now being hoisted. A slew of government crackdowns on everything from real estate developers to tech companies is raising questions about whether a sudden change in regulations could hurt foreign investment in securities.
While positive inflation-adjusted interest rates and relatively subdued volatility keep some fund managers bullish on Chinese sovereign debt, regulatory risk combines with a lackluster credit rating to dampen the appeal. . This makes Chinese bonds a less likely candidate to challenge US Treasuries as global safe-haven assets, hampering Beijing’s efforts to promote global use of the renminbi and undermine dollar dominance.
“I can’t help but feel a higher regulatory risk for the country’s bonds,” said Akira Takei, global fixed-income fund manager at Asset Management One in Tokyo, who has yet to buy the bonds. securities. âWhile I don’t expect any restrictions to be introduced into the Chinese government bond market, I need to consider how stricter regulations outside the bond market will impact overall investment in China. “
The stature of renminbi bonds had grown in line with China’s growing influence on the global economy and as foreign exchange reserve managers bought more securities. Yet now, amid growing isolation from the United States and a sweeping effort to close the domestic wealth gap, China’s changing rule of law landscape threatens to undermine their appeal. for investors looking for a safe haven.
The country’s banknotes ranked sixth of nine debt markets analyzed by Bloomberg for their safe haven qualities in a study that took into account factors such as net foreign assets and volatility. Japanese bonds top the rankings, followed by Swiss and Canadian securities. British gilts came last.
Chinese bonds scored minus 2.72 for rule of law in the Bloomberg survey, the lowest of any market. The securities also performed poorly for credit ratings in the analysis, scoring minus 1.63 to rank last with Japanese debt.
The real estate sector has become a prime example of the risks to investing in China, as tighter restrictions on lending and skyrocketing borrowing costs have led developers to struggle with funding, raising concerns over their creditworthiness. . Kaisa Group Holdings recently joined struggling industry giant China Evergrande Group as its cash crunch reached the point where it hurt investors in high-yielding wealth products.
In the context of the country’s government bonds, one of the main concerns is that a sudden change in the rules could make it more difficult for investors to sell their holdings or repatriate the proceeds.
“If regulations on the movement of capital are tightened, for example by introducing restrictions on market access transactions, foreign investors risk being at a disadvantage,” wrote Mr. Minoru Nogimori, an economist at Japan Research. Institute, in a report.
Despite these risks, foreign investors continued to place billions of dollars in Chinese government bonds. Their holdings increased by 513.7 billion yuan (S $ 110.2 billion) in the first 11 months of the year, the highest on record for that period, according to ChinaBond data dating back to 2014.
According to Frances Cheung, rate strategist at OCBC in Singapore, inflows are likely to continue, as Chinese bonds remain attractive from a real yield spreads perspective.
Of the nine markets analyzed by Bloomberg, only China offers positive inflation-adjusted returns.
These returns and the country’s willingness to open up its financial sector to foreigners suggest that the importance of Chinese debt is more likely to grow, whether viewed as a risky asset or a safe haven.
Mr. Manabu Tamaru, Tokyo Portfolio Manager at Barings, said: “I recognize the risk of a sudden regulatory change.”
But, he added, sovereign bonds are unlikely to be a target as it “would trigger an exodus of foreign funds.”
âSo I think bond investors are in a safe position,â he said.
For Ms. Tracy Chen, Philadelphia-based portfolio manager at Brandywine Global who bought Chinese debt for the first time last year, stocks act as an “alternative haven”, as the second still under-invested bond market in by strangers.
“We see the recent regulatory tightening and deleveraging in the real estate developer industry as painful in the short term, but beneficial for long term growth,” she said. “For us, this is the Chinese version of ESG and should signal better quality growth in the future.”
ESG refers to investments that take into account environmental, social and governance principles.