What are the Missing Pieces in Chinese Fixed Income?

As of April 30, 2015, the fixed income ETF market in China totaled CNY 8 billion; it is only 0.03% of the total market value tracked by the S&P China Bond Index.  The fixed income ETF market in China is small when comparing with that of the U.S., which totaled USD 321 billion as of the same date.

Unsurprisingly, most Chinese investors favor high-risk and high-return products.  They tend not to find the fixed income assets appealing, especially after the recent China stock rally.  However, Chinese investors often overlook the risk component.  As of April 30, 2015, the three-year annualized risk of China’s equity market1 is 19.5% versus 2.77% of Chinese fixed income, represented by the S&P China Bond Index.

Despite the differences in the regulatory landscape and product demand, we believe the China ETF market could learn from the growth seen in the U.S. ETF market as follows:

  1. Investor Education: Fixed income is considered a core asset class in the U.S.  It diversifies portfolio risk and plays an important role in asset allocation.  In order to build up retail investor participation in ETFs, Chinese investors should also learn about why and how they would be benefited from ETFs and passive investing, including cost effectiveness, flexibility, and diversification.
  2. Product Variety: Compared with the limited product types in China, the U.S. has a robust suite of product offerings, including sovereign bonds, corporate bonds, municipal bonds, inflation-linked bonds, convertible bonds, etc.  There is a strong growth potential for both the number and the type of fixed income ETFs in China in the coming years.
  3. Usage of ETFs: ETFs can not only be used for exposures and hedging tools, they can also be used as building blocks for strategic asset allocation or liquid instruments for tactical positions.  However, this is dependent on further improvements in underlying liquidity.
  4. Fixed Income Index (Benchmark) Practices:  The International Organization of Securities Commissions (IOSCO) publishes the Principles for Financial Benchmarks.  It is essential for an index provider to adopt  governance practices that address conflicts of interest and promote transparency.  Meeting investor demand and building investor confidence are  essential to the development of the ETF market.

1China equity is represented by the S&P Total China BMI (USD).


The posts on this blog are opinions, not advice. Please read our disclaimers.

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