Download Buyers Guide to RMB Bonds

Buyers Guide
to RMB Bonds
Main author:
Bryan Collins
RMB bond
investors need
to do their
homework first
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The RMB bond market is a relatively new and exciting investment opportunity, with RMB bond funds
having grown in popularity and number over the past one-to-two years. The growth to date has been
impressive but sorting through the issues affecting the asset class and understanding the risks is
becoming increasingly challenging. This guide aims to outline the key investment strategies on offer in
the market and provides some suggestions as to the questions investors need to ask when selecting
a fund. As always, investment goals vary, so seeking independent financial advice is recommended
before making any investment decision.
There are
three main
types of
RMB bond
funds
Dim Sum
funds
The dim sum market refers to
RMB-denominated and settled funds
issued offshore. Dim sum funds invest
mostly in these securities but may
have some ability to invest in nonRMB denominated bonds that are then
hedged back to RMB.
RMB
hedged
funds
Typically invest in USD-denominated
bonds and are fully hedged back
to RMB. They may not actually hold
any dim sum bonds and can hold
bonds of varying credit quality (high
yield, investment grade, government,
convertible bonds, CNY synthetic
bonds) and can include securities
from various countries, not necessarily
Chinese or Asian issuers. In this group
we can also include bond funds of
any kind that happen to have a fully
hedged RMB share class.
Onshore
RMB
funds
RQFII1 or QFII funds use the developing
Chinese quota system by accessing
the onshore Chinese bond or equity
markets almost exclusively. Although
the onshore Chinese market is large,
it remains relatively undeveloped, so
understanding credit quality, interest
rate risk and liquidity is very important
with these funds. Most onshore funds
invest exclusively in Chinese issuers
as very few multinational corporations
(MNCs) are able to issue in that
market, whereas offshore dim sum and
RMB-hedged funds (i.e. those not using
a QFII or RQFII quota) may invest in
Chinese, Asian or other multinational
issuers more familiar to offshore
investors.
1.The Renminbi Qualified Foreign Institutional Investor (RQFII) scheme permits qualified investors to
channel offshore RMB funds into mainland bond and stock markets. It follows the Qualified Foreign
Institutional Investor (QFII) scheme, which was introduced in 2002 and principally designed to
allow licensed foreign investors to buy and sell RMB denominated “A” shares in China’s mainland
stock exchanges. These quotas are limited in size, subject to change and the manager’s ability to
repatriate funds back offshore can be impaired in certain circumstances.
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Points to note
What’s important to note, as you may have
noticed, is that not all RMB bond funds carry the
same risks, despite having similar names.
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Currency: While they may all offer exposure to
Credit quality: Funds will also vary greatly in terms
the RMB currency, there are several ways to get
exposure to the currency including directly onshore,
via CNH (offshore RMB) or by using currency forwards
for hedging (including CNH deliverable and nondeliverable CNY forwards).
of credit quality, some invest heavily in high yield
bonds, others may focus on investment grade and the
underlying interest rate risks will vary too. Onshore
funds are essentially exposed to Chinese inflationary
and interest rate risks, while offshore RMB hedged
funds may have more implicit exposure to US interest
rate risk if they are buying USD denominated bonds
and hedging them back to RMB. Dim sum funds are
more aligned to onshore Chinese interest rates but
remain somewhat independent. However given the
dim sum market is a relatively short duration market
at this stage, duration risk is typically low and more
dependent on underlying credit risk.
So what
should you
be asking
when
selecting a
fund?
Here are some key questions that we think are important
when trying to gauge the risks and opportunities of
various types of funds and deciding which is right for
you. These questions are also worth considering when
reviewing a fund after a period of time, as fund strategies
can change – a concept known as ‘style-shift’ or ‘-drift’
Questions to Ask:
1. What is the fund’s goal or objective?
Is it income, capital gain or both? Risks attached to
bond funds vary and with higher potential returns, comes
higher risk.
2. What is the fund’s investment strategy?
The fund should have a clearly-stated strategy, so
that it can be easily categorized as one of the 3 fund
types above and the investor can start to gauge risk.
You should also ask whether the fund has any limits
on credit quality -- in other words, does the fund buy
investment grade or high yield bonds or both and in
what combination. High yield is a common component
of many RMB bond funds but that exposure carries
much higher risks than investment grade government
or corporate bonds, so investors must pay particular
attention in this case.
3. What are the main risks of investing in the fund?
Understanding risk is critical to being an informed
investor. Markets can go up and down, and you can
make or lose money in any investment, so understanding
how a fund may react when markets are weak as well as
strong, is also important. Also, given that the RMB bond
market is new, we have yet to see a full credit cycle, so
this aspect can be challenging. Also keep in mind that
past performance is no indicator of what will happen in
the future, and given some funds have flexible strategies,
risks within a fund may have changed significantly.
To help gauge risks we suggest investors break it down
as follows: credit risk, interest rate risk and liquidity risk,
and others. For example:
n interest rate risk: the risk that the value of an
investment will fall as interest rates rise. This is closely
related to inflation risk - the risk that the value of an
investment will be eroded as inflation rates rise (eg.
cash is typically low risk but often does not deliver
a return at or above the rate of inflation. A fund’s
duration will help here – a larger duration means
more sensitivity to rising yields.
n credit risk: the risk that an obligation will not be
paid and this is much higher with more leveraged
companies that issue high yield bonds.
n liquidity risk: the risk that a manager will not be able
to buy or sell an investment quickly because buying
and selling opportunities are limited and/or expensive.
n currency risk: the risk that the fund will lose value due
to fluctuations in the rate of exchange, namely that
the RMB depreciates in value against the USD, EUR or
your base currency.
n political risk: the risk that a foreign investment will
lose value due to unfavourable political or regulatory
changes in that country, including changes to the
convertibility of the RMB or availability of RMB
offshore.
4. What are the fund’s fees and expenses?
Management fees may not include all costs. Upfront
or other ongoing advisor or distributor fees may need
to be included. All managers should be able to tell
you this and will include this information in the offering
documents or prospectus.
How readily can I buy and sell the fund’s shares or
units?
Many funds are priced daily allowing you to buy and
sell readily, others may be only available once a week
or month. For funds that price daily, some may also not
price during special holiday periods, such as Chinese
New Year, whereas others may still be open.
5. How are the fund’s distributions determined?
If the fund pays a distribution you should know whether it
is paid based on the underlying income generated by the
bonds it holds or whether the distribution is sometimes
supplemented by paying out any capital gains (or losses)
generated. Also ask whether any FX hedging gains are
used to supplement income, because this may increase or
decrease income as well as the value of the investment if
the RMB moves against other currencies.
6. What information is available about the fund?
Ask for regular updates, top holdings, information on
portfolio concentration, yield to maturity (YTM) as well
as distribution yield (running yield), the fund's duration
(interest rate sensitivity), number of issuers as well as
the number of securities and ask for the average credit
rating and breakdown (if the fund has large exposures
to non-rated bonds, these are often of lower quality, so
the manager should be able to give you an equivalent
rating). Knowing the number of issuers and securities
is important to evaluate concentration risk, as all other
things equal, fewer names and concentrated exposure
results in higher risk.
7. What’s the investment horizon?
A relatively simple question to ask but where the answer
will invariably depend on your own investment goals. In
general, the riskier the fund, the longer the investment
horizon should be to weather any volatility.
8. How do I benchmark performance?
It is always important to measure return given the
underlying risks. This may not always mean how has
the fund performed against an index but also how has
it performed against other funds of similar risk. While
there are now many indices to compare, they, just like
the various RMB bond fund strategies, vary significantly
and so may not always provide a definitive comparison,
but they do help understand differences in return and
volatility. As a good rule of thumb, first get comfortable
with the investment strategy and risks.
In summary: ‘If something sounds too
good to be true, it probably is.’
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Table
Some onshore RMB bond funds have drawn attention to the superior yields on offer versus Dim Sum bonds currently, but investors should gauge the full risk/return profile of a fund before
investing. We list the key differences below:
Offshore/CNH RMB bond market
Onshore/CNY RMB bond market
CNH RMB deposits
Market size
RMB360 billion
RMB22042 billion
RMB448 billion
Issuer composition
China, Hong Kong and overseas corporates
n China
n Some
n Mostly
Sector
state-owned enterprises (SOE) related
n 59%corporates
n 41% treasury bonds,
n 26%corporates
n 74%government
banks and financial institutions
protected by the Deposit Protection
Scheme, with a compensation limit
n Deposits
n/a
central bank
notes and policy
bank bonds
Number of issuers
>100
<200
n/a
Number of securities
>150
>3000
n/a
Daily liquidity
Yes
Yes
No
Redemption Penalty
No
No
Penalty: forfeit interest and incur administration fee
Yield
3-5%
3-5%
Variable, with higher rates mainly for promotional
periods
Duration
2-3 years
4-5 years
n/a
Accessibilities
Requires no quotas
Requires a QFII or RQFII quota
Subject to RMB conversion limit for HK residents
Rating agencies
International rating agencies e.g. S&P, Moody’s, Fitch, etc. Local rating agencies
n/a
Credit rating composition
n Rated:
65%
n Unrated: 35%
Mostly unrated by international rating agencies
n/a
Transparency
High
Low
High
Tax
No withholding tax
Withholding tax on interest income
No tax
Governing law
HK, UK, US and Europe
PRC
HK
Source: FIL Limited, Citi Research, September 2012; HKMA, Hong Kong Deposit Protection Board, January 2013
Please note RMB is not freely convertible and is subject to exchange control imposed by the Chinese government. There is no assurance that RMB will not be subject to devaluation. RMB debt securities and bank deposits are typically
unsecured debt obligations not supported by any collateral, which are generally subject to a higher credit risk.
FIL Limited and its subsidiaries are commonly referred to as Fidelity or Fidelity Worldwide Investment. Fidelity only gives information about its products and services. Any person considering an investment should seek independent advice
on the suitability or otherwise of the particular investment. Investment involves risks. Past performance is not indicative of future performance. Please refer to the Fidelity Prospectus for Hong Kong Investors for further information including
the risk factors. If investment returns are not denominated in HKD or USD, US/HK dollar based investors are exposed to exchange rate fluctuations. Fidelity, Fidelity Worldwide Investment, the Fidelity Worldwide Investment logo and F
symbol are trademarks of FIL Limited. The material is issued by FIL Investment Management (Hong Kong) Limited and it has not been reviewed by the Securities and Futures Commission (“SFC”).
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