Overall, 2017 was a quiet year for the Chinese bond market. As represented by the S&P China Bond Index, the one-year total return was down by 0.29% (see Exhibit 1), contrasting with the strong gains observed in previous years. China’s lackluster performance made it the worst-performing country in the Pan Asian bond market in 2017, and it was also the only country that closed the year in negative territory.
The launch of the Bond Connect program in July 2017 widened access to China’s onshore bond market, bringing positive momentum to the market and helping recover some of the losses seen in the first half. However, deleveraging and liquidity concerns persisted in the second half, and these negative sentiments weighed on the market.
The S&P China Bond Index also underperformed the broad market. The S&P Global Developed Aggregate Ex-Collateralized Bond Index (USD) seeks to track the performance of investment-grade debt issued by sovereign, quasi-sovereign, foreign government, and corporate entities in developed countries, and it delivered a total return of 7.64% in 2017. Specifically for the corporate bond sector, China had been lagging its U.S. counterpart. The S&P 500® Bond Index is designed to measure the performance of U.S. corporate bonds issued by the constituents of the iconic S&P 500, and it rose 6.05% last year, compared with the 0.58% gain for the S&P China Corporate Bond Index.
Looking into the China bond market, the S&P China Government Bond Index dropped 0.75% in 2017, underperforming the S&P China Corporate Bond Index, which gained 0.58% during the same period (see Exhibit 2).
Among the government bonds, the S&P China Provincial Bond Index was the most volatile subindex; it dropped as much as 4% before closing the year down 0.97%. The S&P China Agency Bond Index, which tracks the three policy bank bonds, was the most resilient subindex and fell only 0.46%. The S&P China Sovereign Bond Index remained in negative territory throughout the year, falling 0.98%.
While all corporate sector-level indices were up in 2017, the S&P China Services Bond Index was the biggest winner and rose 2.0%, followed by the S&P China Utilities Bond Index, which gained 1.66%. The S&P China Financials Bond Index only climbed 0.19%, reflecting that the tighter liquidity and higher funding cost could have been a drag on the financials sector.
The market value tracked by the S&P China Bond Index rose 13% last year; there were a total of 9,933 constituents with CNY 56 trillion. The growth in size was led by government bonds, which advanced 17%, compared with the mere 4% increase of corporate bonds over the same period, a consistent trend since 2014. Meanwhile, the corporate bond market expansion, which started in 2007, has been slowing down, reflecting the industry consolidation and possibly also higher financing costs due to surging yield. Exhibit 5 shows market value and growth in the past 10 years.
Despite the slowdown in corporate bond issuances, they maintained their overall exposure and represented 31% of the China bond market as of Dec. 29, 2017 (see Exhibit 6).
Among the government bonds, provincial bonds recorded significant growth, despite the volatility in performance; 801 provincial bonds with a total market value of CNY 4.21 trillion were added to the S&P China Provincial Bond Index. Its market value increased 39% to CNY 13.6 trillion in 2017. Among the new issuances, the largest issuers were the Jiangsu, Sichuan, and Shandong provinces. The top 10 new issuers in 2017 are listed in Exhibit 7.
For corporate bonds, financials was the only sector that recorded expansion, while the utilities, services, and industrials sectors contracted. The utilities sector, represented by the S&P China Utilities Bond Index, had a drop in market value of 28% to CNY 916 billion, reflecting the impact of China’s power sector reform. According to the index, there were a total of 199 bonds with a market value of CNY 583 billion that matured last year. Considering the matured and issued profiles, Exhibit 8 displays the top 10 issuers that resulted in negative net flows. The top three were State Grid Corp, China Huadian Corp, and China Datang Corp (note that the first two did not have any issuance in 2017). Even for those issuers that managed to sell new bonds, the sizes were a fraction of what had matured. Note that while the State Grid Corp of China didn’t issue any CNY bonds last year, it raised money with a USD multi-tranche bond in the U.S. market. With the higher local financing cost and strengthening of CNY, a rising trend of Chinese corporates tapping into USD bond market has been observed.
In spite of their performance, Chinese bond yields are attractive, considering their relatively short duration. As of Dec. 29, 2017, the yield-to-worst of the S&P China Bond Index was 4.78%, which widened 178 bps over the 12-month period, with a modified duration of 3.7 (see Exhibit 9). As a comparison, the yield-to-maturity of the S&P Global Developed Aggregate Ex-Collateralized Bond Index (USD) and the S&P 500 Bond Index were 1.41% and 3.28%, respectively. China’s solid economic growth and the underparticipation of foreign investors may also serve as positive drivers for the China bond market.