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NOV. 30, 2020

China’s potential rise in Developed Market Portfolios

So far, the share of Chinese assets in global equity and fixed income portfolios remains very modest, representing a substantial significant structural underweight, and has room to grow further. This process could be further facilitated by a strategy shift from the incoming Biden administration to a less combative trade policy and towards multilateral agreements and institutions.

The global Coronavirus pandemic, among other events, overshadowed China’s entry into Bloomberg’s bond indices (April 2019) and J.P. Morgan’s Emerging Market bond index (February 2020) as well as in other mainstream global bond indices. This constituted a major milestone in the “opening” of the country’s capital markets, and confirms Asia’s rise in the Emerging Market asset class. We believe that this will likely lead to increased capital inflows into China for both Bonds and Equities. According to JPM’s estimates, the Chinese marketable debt market is now the 2nd largest globally (U.S. debt being in 1st place) and has grown too big to ignore with a size of $13trln, even though the inclusion of Chinese global indices has thus far supported moderate foreign investor flows into Chinese onshore assets.

In fact, the inclusion of onshore Chinese assets into global indices is the first step on a roadmap that will eventually make them into important components of global equity and fixed income portfolios. Nevertheless, full index adoption assumes no foreign ownership limits, abolishment of the quota system, and full liberalization of capital mobility restrictions and alignment of international accessibility standards. It seems that China has (slowly, yet steadily) been moving towards to the right direction by “allowing” the establishment of both the Northbound Hong Kong Connect program (HKEX[1]) as well as the Bond Connect[2] program.

According to HKEX, in January 2015, 3 months after the Shanghai-Hong Kong Stock Connect was launched, Northbound Stock Connect funds accounted for a mere 5% of the nearly 600 bln yuan ($86.6 bln) of foreign capital market investment in mainland China, with the majority invested under the qualified foreign institutional investor (QFII) and RMB QFII (RQFII) schemes. However, by December 2019, that proportion had increased to around 68% of the approximately 2 trillion yuan ($289 bln) worth of Chinese A-shares held by foreign investors. Bond Connect monthly trading volume reached record high, hitting RMB 485 billion in November[3].

We think that as the index inclusion process advances, the market continues to reform, as well as further improvements in market accessibility take place, international investors will likely come under heavy pressure to add exposure to Chinese risk assets.

We thank you for your continued support.

LARA AND JOHN