U.S. investment firms are readying the first line of exchange-traded funds designed to give American investors access to China's swelling onshore bond market, which has been largely closed off to foreigners.
At least four fund managers - Deutsche Bank AG, Global X Funds, KraneShares and Van Eck Global - have outlined plans to launch China onshore bond ETFs, according to company filings with the U.S. Securities and Exchange Commission. The first of the funds could launch as early as this month, sources familiar with the matter say.
Some of the funds will invest in a range of yuan assets, including government and corporate bonds, while others will be more specialized, focusing on commercial paper, for example. They will be targeted at both institutional and retail investors.
Gaining access is no small thing for investors. The government-related bond market is about $3 trillion (18.4 trillion yuan) and China's domestic corporate bond market has grown to about $1.5 trillion (9 trillion yuan) at the end of August, after companies raised a combined $261 billion (1.6 trillion yuan) from bond issuance in the first eight months of the year. In June, credit agency Standard & Poor's said the Chinese corporate bond market overtook the United States as the world's biggest and is now set to soak up a third of global company debt needs over the next five years.
While onshore Chinese bonds carry the currency, default and regulatory risks that might be expected in a fledgling market, their relatively high yields and low correlation to U.S. Treasuries and other global fixed-income and equities markets will make them appealing to investors, analysts say.
"Yield levels are attractive," said Cecilia Chan, chief investment officer of fixed income for the Asia Pacific region at HSBC Global Asset Management, in a telephone interview. She expects U.S. and European investors to look to China for yields they can't get in their own regions.
Ten-year yields on Chinese government bonds are hovering around 4 percent, compared to about 2.3 percent in the United States and Britain. If, as some investors expect, the Chinese economy slows further, then the value of high-yielding bonds will likely be bolstered as interest rates fall.
"The ability to be able to access that market, either by retail or institutional investors, is very appealing," said Bruno del Ama, chief executive officer of New York-based Global X Funds, because the burgeoning market has historically been out of reach for foreigners, even big investors. As the market expands and China relaxes its tight control over onshore assets, more investors may want to take part, he said.
Nevertheless, headwinds still exist.
For starters, there's the government-run quota system which limits foreign access to China's onshore market. Only about $108 billion (662.2 billion yuan) had been approved for foreign investment in the mainland's securities markets, including stocks and bonds, under the country's Renminbi Qualified Foreign Institutional Investor (RQFII) and Qualified Foreign Institutional Investor (QFII) programs, by the end of September.
To access those onshore bonds, U.S. fund issuers will have to partner with approved asset managers, mainly based in Hong Kong, and could find their supplies limited.
The operational complexity of these ETFs is in part reflected in the higher fees they are expected to demand. The KraneShares fund, for example, will charge 0.68 percent in annual management fees, while the Global X fund is expected to cost 0.65 percent in annual management fees. Deutsche and Van Eck Global have not yet disclosed fees.