KraneShares, a newcomer in the ETF space specializing in China, recently filed paperwork with regulators for a China government bond ETF, putting “dim sum” bonds back on ETF investors’ maps.
According to the filing with the Securities and Exchange Commission, the KraneShares CSI China Government Bond ETF plans to hold Chinese Government Bonds (CGBs)—including bonds of policy banks and state-owned banks—issued outside of mainland China. The fund plans on targeting intermediate-term bonds, with maturities of 10 years or less.
While innovation in China equity ETFs—including access to China’s domestic “A-share” market—has been on most China investors’ minds, there’s also been a burgeoning dim sum bond market in Hong Kong that’s often overlooked.
First a bit of background.
Dim sum bonds are yuan-denominated bonds that are issued outside of mainland China—currently mostly issued and traded in Hong Kong. Dim sum bonds include a hodgepodge of government and corporate bonds issued by both Chinese and non-Chinese entities.
For example, foreign companies like McDonald’s, Caterpillar, Ford, Unilever, BP, Volkswagen, Rabobank, Renault and VTB Bank have also issued dim sum bonds in Hong Kong, to name just a few.
While there are already three dim sum bond ETFs in existence, the new KraneShares fund looks to separate itself from the pack by holding bonds of any rating issued only by Chinese government entities (CGBs and state-owned bank issues).
In comparison, the PowerShares Chinese Yuan Dim Sum Bond Portfolio (DSUM) currently holds a broad mix of more than 85 investment-grade, below-investment-grade and unrated sovereign and corporate bonds from both Chinese and non-Chinese entities.
The other two choices—the Market Vectors Renminbi Bond ETF (CHLC) and the Guggenheim China Yuan Bond ETF (RMB)—hold smaller portfolios of sovereign and corporate bonds. While they both target only investment-grade bonds, Guggenheim’s RMB has the stricter mandate.
RMB holdings have to be rated investment grade by at least one of the “big three” rating agencies (S'P, Moody’s or Fitch), while Market Vectors’ CHLC offers more wiggle room, looking beyond just the “big three” and allowing bonds rated investment grade from a local rating agency.
Should the new Kraneshares ETF launch, it would be stepping into a niche theme that, so far, hasn’t quite resonated with most U.S.-based investors. The existing three funds only have a combined $80 million in assets, of which $72 million is in one fund, PowerShares’ DSUM.
RMB and CHLC, which only have $2.6 million and $5.3 million in assets, respectively, have also been plagued by extremely thin on-screen volume, sometimes going for days without any trading activity (see the choppiness in the chart below).
I’ve been quite surprised at the lack of interest in dim sum bond ETFs since the three funds launched within a month of each other in late 2011. I’m surprised mainly because these China bond funds have been largely ignored during a period of massive assets inflows into other emerging market debt ETFs.
Total AUM for emerging markets fixed-income ETFs is now over $13.7 billion, as investors have largely put aside credit risk to chase higher yields in recent years. Even the two broad emerging markets high- yield ETFs that launched after the three dim sum ETFs have nearly $250 million in assets apiece.
This might suggest that investors are wary of the credit risks associated with dim sum bond issuers (a legitimate concern), but again, how many investors piling into many emerging market bond ETFs truly understand the credit risks involved?
I think a better explanation is that perhaps the dim sum bond market is simply less understood.
One of the biggest draws for dim sum bonds is their yuan-denomination, giving investors direct currency exposure to offshore renminbi traded in Hong Kong (CNH), while collecting yields of 2-3 percent at the same time.
Plus, not all dim sum bonds are even below investment grade. To the contrary, many of them have investment-grade ratings from one or more of the three big rating agencies. So I’m not convinced it’s the credit risk that has been shunning investors away thus far.
I find it interesting that of the three existing funds, it looks like PowerShares’ DSUM—which includes bonds of any rating, including unrated bonds, and that has the highest yield of the bunch—is clearly pulling away from its “investment grade” peers in assets and liquidity in recent months.
Even with the slow start around dim sum bonds in the U.S., Kraneshares is not alone in filing for an ETF to target this nascent but fast-growing market. WisdomTree also has a filing for the WisdomTree China Local Debt Fund, an actively managed fund that will include dim sum bonds of both investment-grade and below-investment-grade quality.
As the offshore renminbi market grows, we should see more innovation in China ETFs coming our way, not only on the equities front, but also on the fixed-income front as well.
Dim sum bond ETFs provide another way to invest in the renminbi’s internationalization, and can be used to complement equity exposure for investors looking for a more comprehensive “Total China” portfolio.
At the time this article was written, the author held a long position in DSUM. Contact Dennis Hudachek at email@example.com.
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