Chinese government bonds: How do they measure up in a multi-asset framework?

China’s government bond market is the third largest in the world (behind only the US and Japan) and is of growing interest to foreign investors thanks to continued market liberalization and improving liquidity. In this paper, the second in a series on allocating to China in a multi-asset portfolio (see our previous paper on separating China and EM ex-China equities), we examine the potential benefits of including Chinese government bonds (CGBs) in a portfolio.

In particular, we consider the extent to which CGBs can help diversify a broader government bond portfolio, improve yields relative to developed market (DM) government bonds, and offset equity risk. In summary, we find that CGBs:

• Have low correlations with DM government bonds
• Do not share the common “global duration driver” that DM yields do
• Are negatively correlated to global equity risk

We also address a number of challenges and considerations that we believe investors should bear in mind, including currency exposure, China’s unique policy environment, and the potential for CGBs to become more correlated to other bond markets over time.

A brief overview of the Chinese government bond market

CGBs are issued and backed by the central government of China. Policy financial bonds (PFBs), also known as policy bank bonds, are issued by the three policy banks of China (China Development Bank, Agriculture Development Bank, and Export-Import Bank) but have the explicit funding support of the People’s Bank of China (PBOC) in times of need and therefore have the same credit quality as CGBs. As such, CGBs and PFBs trade broadly in line with each other, with pricing differences largely reflecting…

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