Chinese sovereign bonds will have the sixth-largest weighting in FTSE Russell’s flagship World Government Bond Index, though global investors have three times longer than they expected to grow their holdings to that level.
The index compiler will add Chinese bonds in October in phases over a period of three years, longer than the 12 months initially envisioned after market feedback, FTSE said in a statement. They would comprise 5.25% of the index on a market value-weighted basis, based on prices as of March 25, giving China a slightly bigger weighting than the UK.
Global funds have already been piling into Chinese sovereign debt, which has acted as a haven during the recent bond selloff, given its yield advantage and inclusion in two other bond indexes. Still, the longer phase-in period for FTSE indicates some investors are concerned about issues including market liquidity, while Japan’s Government Pension Investment Fund has also been waiting on the decision.
“It’s a sensible decision for a slower process given the potential sizable monthly inflow,” said Becky Liu, head of China macro strategy at Standard Chartered Plc. “It highlights the still slow process of accessing China’s onshore bond market by some investors, likely Japanese lifers who are one of the key users of the WGBI, but still it’s very good news to induce broader-based global investments into China.”
Liu expects China sovereign bonds to see total inflows of $130 billion to $156 billion from the inclusion, which could boost foreign buying this year to as much as 1.5 trillion yuan ($228 billion), or at least 30% higher than 2020. Analysts from HSBC Holdings Plc. and Maybank Kim Eng are forecasting inflows of $130 billion.
China Bonds to See Inflows of $105b to $156b From FTSE Inclusion
The WGBI is widely followed by Japanese investors, including GPIF, which manages $1.6 trillion. Purchases of Chinese bonds by Japan started to pick up in late 2016 and the pace has accelerated in the past two years, according to balance-of-payments data from Japan’s Ministry of Finance. A rolling 12-month sum of net buying reached 707.4 billion yen ($6.4 billion) in January.
China’s loose correlation with other debt markets has been a major reason for its outperformance amid a selloff in global peers. The nation’s 10-year benchmark bond yield has risen just four basis points this year compared with a more than 80 basis point climb in yield for similar-dated Treasuries. Still, there’s a spread of around 145 basis points between the two securities.
Global investors bought about 320 billion yuan of Chinese debt as of the end of February, according to data from the central bank. They own around 11% of the Chinese sovereign bond market, Bloomberg calculations show.
“A more conservative implementation schedule is appropriate” due to the passive nature of the index mandate and the inflows expected from the inclusion, FTSE said in the statement. “Some clients may need longer onboarding time to access the market.”
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The World Government Bond Index comprises of debt from more than 20 countries, with Japan having the biggest weighting in Asia at more than 16% once China’s inclusion is complete. The index provider owned by the London Stock Exchange Group adjusted its inclusion threshold for Chinese government bonds just this month following feedback from market participants.
“China’s bond market has already been the second largest in the world, so isn’t a surprise for China to have a similar weighting as the UK.,” said Tommy Xie, head of Greater China research at Oversea-Chinese Banking Corp. Chinese sovereign bonds could see inflows of about $150 billion from the inclusion, while foreign ownership will likely rise further to as much as 20% of the total, he said.
FTSE is the last of the three main index compilers to add Chinese debt after Bloomberg Barclays and JPMorgan Chase & Co. It announced the decision in September. Bloomberg Barclays is owned by Bloomberg News parent Bloomberg LP.
— With assistance by Livia Yap, Wenjin Lv, and Masaki Kondo
(Updates with more analyst flow estimates in fifth paragraph)