China Leads Emerging Asia to Greater Role in Capital Markets

China Leads Emerging Asia to Greater Role in Capital Markets
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China Leads Emerging Asia to Greater Role in Capital Markets

Investors absorbed by the latest Chinese currency move may be losing sight of the big picture: China and the entire emerging Asian region are gradually being integrated into global capital markets. Over the next 12 to 24 months, we expect that Asia, led by China, will become a far more significant part of the global capital markets – and global investment portfolios.

As investors today search for income in the low-return environment, Asian markets are entering the global sphere at an opportune time. As the force driving the region, China is opening its huge markets to global investors, presenting attractive long-term opportunities for both above-market return (alpha) and market gains (beta).

China: the driving force

Currently the world’s second-largest economy by GDP, China has the largest banking system in the world by assets, the second-largest equity market by market capitalization at well over $7 trillion, the second-largest corporate credit market and the third-largest government bond market. With foreign participation in China’s local markets estimated at about 4%, growth in investment in China over the next few years has the potential to be the fastest in the history of capital markets.

While its offshore markets have been traded widely for some years, China is now focused on opening its onshore, local currency markets. Starting in 2015, the People’s Bank of China (PBOC) fully liberalized access to the onshore fixed income market for official entities like central banks and sovereign wealth funds. Others have gained access through the country’s institutional investor programs, direct yuan investment quotas and bilateral agreements.

After announcing in 2016 that it would expand foreign access to the bond market, the government opened the “Bond Link” program in early July of this year to allow foreign investors to buy domestic bonds from mainland Chinese issuers through a link with Hong Kong. The country’s “Stock Connect” programs, introduced in 2014 for the Shanghai Stock Exchange and 2016 for Shenzhen, similarly link investors to mainland equity markets via Hong Kong.

Index inclusion key for Chinese equities and bonds

As China’s markets become more accessible, its securities are set to be included in the major stock and bond indices – the key to participation for many global investors. Demand is expected to increase dramatically as investors buy the securities in the indices, or very similar ones, to mirror their portfolio benchmarks. One of the largest index providers, MSCI, decided in June it will begin including more than 200 China A-shares (issued by the country’s biggest and most well-known companies) in its global emerging market equity indices starting in May 2018. Estimates for flows into equities as a result of the MSCI “benchmark effect” range from $200 billion to $400 billion.

As Chinese securities are included in widely followed fixed income indices, expected over the next one to two years, flows could increase by the same amount over multiple years. For emerging market investors, Chinese yields would tend to be lower than their emerging market index averages, but for global investors, China’s yields are currently two to three times higher than global index averages.

China's huge market potential

Greater demand typically spurs greater supply in the capital markets, and the potential for growth in issuance in China’s capital markets is huge. Standard & Poor’s has estimated that China’s share alone of global corporate debt outstanding will rise to 43% in 2020 from 35% in 2015.

The IMF’s inclusion of the yuan as a reserve currency in 2016 was a harbinger of China’s arrival in the global markets; soon, the addition of Chinese equities and bonds in global indices will signal its entrance. In anticipation of that, we think global investors may want to define – or refine – their long-term strategy in the region. 

For more on our outlook for the region, see China and Emerging Asia: A New Dawn for the Capital Markets.

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Luke Spajic leads emerging markets portfolio management in Asia and manages Asian credit portfolios.  

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Disclosures

All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Equities may decline in value due to both real and perceived general market, economic and industry conditions. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets.  Investors should consult their investment professional prior to making an investment decision.