What are the Missing Pieces in Chinese Fixed Income?

As of March 31, 2015, the fixed income ETF in China totaled approximately 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 in China is small if comparing with that of the U.S., which totaled USD 318 billion as of the same date.

Unsurprisingly, most Chinese investors favor high-risk and high-return products; they do not tend to find the fixed income assets appealing, especially after the recent China stock rally.  However, Chinese investors often overlook the risk component.  As of March 31, 2015, the three-year annualized risk of China’s equity market1 is 17.5% versus 2.70% of Chinese fixed income, represented by the S&P China Bond Index.

Despite the differences in regulatory landscape and product demand, we believe there are a few key takeaways from the growth seen in the U.S. ETF market.

  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 benefitted 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. Independent Fixed Income Benchmark: IOSCO publishes the Principles for Financial Benchmarks. It is essential for an index provider to be independently governed and use transparent pricing.  Meeting investor demand and building investor confidence are essential to the development of the ETF market.

This article was written by Michele Leung, associate director, fixed income indices, S&P Dow Jones Indices.

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