Q&A with Teresa Kong, Portfolio Manager: China's Inclusion into the FTSE Russell World Government Bond Index
Given today's announcement by Index provider FTSE Russell to add Chinese government bonds (CGBs) to its flagship World Government Bond Index (WGBI) in October 2021, we sat down with Teresa Kong to get a better understanding of the context and implications.
What is the significance of China's inclusion into the FTSE Russell World Government Bond Index (WGBI)?
This is the second of the one-two punch that establishes China's integration into the global bond markets. With the overwhelming majority of all global bond funds benchmarked against either the Bloomberg Barclays Global Aggregate Index (Bloomberg Agg) or the WGBI, these two indices are the heavyweights of bond indices. The Bloomberg Agg started including China in April 2019. So with FTSE Russell's announcement today, it validates China's rise in global capital markets.
How has the path to index inclusion been for bond versus equity indices?
While China is being included in the equity indices as an emerging market, it is being included by bond indices as a developed market. This is an important distinction. Being a part of these global bond indices means being part of less risky, easily assessable investment grade club with substantially more invested capital than the emerging markets.
What is the impact on global portfolio flows?
Assuming China›s weight to be around (6%) and US$2 trillion of assets tracking the WGBI, we estimate inflows to be about US$120 billion just from dedicated global bond investors. If we also include cross over investors as well, total inflows will likely be well north of US$120 billion once China achieves its full weighting in the index.
What is the impact on portfolio returns?
We expect China to be accretive to global bond investors. With 10 year bond yielding around 3.12%, China bonds currently offer higher yield than every other country in the WGBI, with the only exception of Mexico. The WGBI is dominated by U.S., EU, and Japan, with bonds hovering around zero. So 3% is an attractive yield for global investors willing to take on local currency risk.
What about risk?
The volatility of the Chinese renminbi has historically been among the lowest of any global currency, so its volatility adjusted yield is even more attractive. Additionally, China bonds have had very low correlation with other major asset classes. That, coupled with the low volatility of the currency, adding China bonds may be one way to reduce a global bond portfolio's overall volatility.
You mention currency, do you expect this to impact the Chinese renminbi?
We don't think adding China to the WGBI will materially impact the Chinese renminbi. Because China's savings is still greater than its investments, it enjoys a current account surplus and is not reliant on foreign capital inflows. In fact, China is already the single largest national / supranational creditor, bigger than the World Bank and the IMF. We believe developing a more liquid bond market with increasing foreign participations can solidify China's importance as a global creditor, providing pathway for more loans to be denominated in the Chinese renminbi to minimize asset liability mismatches. From a long-term perspective, this is just another milestone on the renminbi's path to potentially becoming a third reserve currency along with the U.S. dollar and the Euro.
Fixed income investments are subject to additional risks, including, but not limited to, interest rate, credit and inflation risks. Investing in emerging markets involves different and greater risks, as these countries are substantially smaller, less liquid and more volatile than securities markets in more developed markets. Securities denominated in a foreign currency are subject to the risk that the value of the foreign currency will increase or decrease against the value of the U.S. dollar.
The Barclays Global Aggregate Index (GAI) provides a broad-based measure of the global investment grade fixed-rate debt markets. The GAI contains three major components: The U.S. Aggregate Index, the Pan-European Aggregate Index, and the Asian-Pacific Aggregate Index. In addition to securities from these three benchmarks (94% of the overall Global Aggregate market value as of December 31, 2010), the Global Aggregate Index includes Global Treasury, Eurodollar, Euro-Yen, Canadian and Investment Grade 144A index-eligible securities not already in the three regional aggregate indices.
The FTSE Russell World Government Bond Index (WGBI) is a broad index providing exposure to the global sovereign fixed income market. The Index measures the performance of fixed-rate, local currency, investment-grade sovereign bonds. It comprises sovereign debt from over 20 countries, denominated in a variety of currencies.