Renminbi-denominated bonds sold outside of China, or dim sum bonds, have always been a relatively small market. And it’s a market that’s now getting smaller.
It wasn’t long ago that dim sum bonds (named after the little dumplings) were the next big thing. But now the dim sum market is shrinking, and if China’s currency weakness continues, it will get even smaller.
From the first dim sum bond issue of RMB 5 billion (US$750 million) in 2007, issuance of dim sum bonds grew to RMB 324 billion (US$49 billion) in 2014. Foreign investors were drawn to dim sum bonds because they were one of the few ways for foreigners to own renminbi-denominated investments. The RMB was for years appreciating against the U.S. dollar, which was good for renminbi-denominated holdings. And dim sum bonds paid an average interest rate of around 4%, which was a far better yield than many other fixed income markets and instruments.
That all changed in 2015, when the volume of new dim sum bonds issued fell nearly 50%, to RMB 163 billion (US$24.8 billion), according to Thomson Reuters. Part of that decline was because a big draw of dim sum bonds – exposure to a currency that was appreciating relative to the U.S. dollar – vanished in August, when China’s central bank took steps to devalue the renminbi. The total return of dim sum bonds in U.S. dollars was negative 3.2% for 2015.
Also, dim sum bonds are no longer one of the only ways for foreigners to invest in renminbi-denominated instruments. Now it’s a lot easier for foreign investors to access the mainland China bond market. With the launch of the Renminbi Qualified Foreign Institutional Investor Program (RQFII), qualified investment companies can channel funds to the mainland Chinese market. Finally, the rally in Chinese shares – until June 2015 – diverted funds from the fixed income market.
Markets, and investors, move towards liquidity – that is, where there are a lot of other investors trading. Better liquidity means better prices for everyone, and it’s easier to sell (or buy) when you want to. The dim sum market as a whole is relatively small. The value of outstanding bonds totaled US$78.4 billion in April 2015 – about 1.5% the size of the US$5.3 trillion of the mainland Chinese bonds market. So both issuers and investors would need a good reason to go to a smaller, less liquid market.
What’s more, After a series of cuts, interest rates in mainland China have fallen. The current yield for mainland China 10-year government bonds is 2.8%, compared to 3.7% for a similar government of China 10-year dim sum bond. Bond issuers will obviously go where they can pay the least amount of interest, which is now the mainland market.
With fewer investors interested in buying RMB, the Chinese government making it easier to invest in mainland China and its much larger bond market, and companies getting better rates in China than outside China, the dim sum bond market’s early advantages are disappearing.
But they’re not gone altogether. Dim sum bonds follow global bond market disclosure and regulatory standards more closely, making them appealing to non-Chinese firms wanting to issue RMB-denominated bonds – and to investors who are nervous about the mainland China market.
The renminbi is likely to continue to weaken as Chinese authorities try to figure out how to navigate the slow process of currency liberalization. But over the long term, demand for the newest reserve currency will be strong. And for investors who can’t access mainland China investments through RQFII, dim sum bonds are still a higher-yield way to own China’s currency.
For exposure to the dim sum bond market, try the PowerShares Chinese Yuan Dim Sum Bond Portfolio ETF (ticker DSUM) on the NYSE, or the iShares RMB Bond Index ETF on the Hong Kong exchange, stock code 83139.