Time for Caution on “Dim Sum” Bonds
The fast-growing market in “dim sum” bonds has been an enticing choice for foreign investors with an appetite for assets denominated in China’s currency, the renminbi. But recent rule changes by Chinese regulators that open the market to further issuance may give investors a bellyache in the near term.
Dim sum bonds are bonds denominated in renminbi (also known as yuan) but issued outside of mainland China.
In October, the People’s Bank of China issued a long-awaited administrative measure that makes it easier for investors to use renminbi raised overseas for direct investment in mainland China. This week, Chinese regulators reportedly agreed on other measures that will allow qualified foreign investors to raise up to RMB20 billion (US$3.1 billion at the current exchange rate) in the Hong Kong market to invest in mainland China’s A-share and bond markets.
We think these measures are a big step toward internationalization of the renminbi, which will likely encourage more issuers to come to market. We are long-term bulls on both the Chinese currency and the dim sum bond market. But in the near term, we think that the new regulatory measures argue for a bit of caution.
The opening of China’s currency market has led to a flood of funds into offshore renminbi accounts (Display). Issuance of dim sum bonds has soared, with the market tripling to RMB210 billion year to date. Some observers expect the market to reach RMB450 billion by the end of 2012.
But there are serious questions about how easily the market will digest all this new supply. The average yield on dim sum bonds has spiked to 3.80% from 2.35% in just the past five months. With the prospect of much more issuance in the pipeline, yields could rise even further.
We think that this validates our view that an exclusive focus on the dim sum bond market is risky for bond investors who want exposure to renminbi. Limited diversification by industry and issuer is another problem: some 70% to 80% of dim sum bonds are backed by the government, banks or property.
Our preferred approach to tapping the attractive yields and appreciation potential of the Chinese currency is to invest in the broader universe of Asian bonds and hedge the returns into renminbi. In a world where the “risk-free” status of many sovereign issuers has come under question, Asian countries score relatively high in terms of creditworthiness. Average yields on Asian bonds are also significantly higher than those on US, Japanese and German bonds.
Ultimately, we think the Chinese bond market could become one of the biggest in the world, rivaling the European and US markets. But there are likely to be many twists and turns along the way. In our view, dim sum bonds should be a key component of any longer-term Asian bond strategy, but now is not the time to rush into the market.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
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Hayden Briscoe is Director of Asia Pacific Fixed Income at AllianceBernstein