An Introduction to Dim Sum Bonds
Most people think of dim sum as the Chinese teatime meal that consists of dumplings and other snacks served by waiters pushing steam carts around the dim sum parlor. But for global investors, the term “dim sum” also refers to the offshore Renminbi (RMB) bond market. The currency in which these bonds are denominated is also referred to as Chinese Offshore Yuan (CNH). This fast growing market was established in 2007, but didn’t take off until last year.
Under current rules, the dim sum market allows domestic and foreign companies to issue bonds that are denominated in RMBs. The rapid accumulation of RMB deposits in Hong Kong is largely fueling the fast growth of the dim sum market, as investors buy dim sum bonds to earn a better return on their deposits. The dim sum market experienced record issuance during the third quarter, with around USD21.3 billion of new bonds. At present, the total size of the dim sum market is around USD30 billion and growing.
Sources: Bloomberg, Hong Kong Monetary Authority
Although the Chinese government has issued some dim sum bonds, the market is largely comprised of bonds issued by corporations from China and abroad. As the chart below depicts, China-based issuers dominate the market, but recently foreign companies have also been increasing their presence. Indeed, companies like Caterpillar (NYSE: CAT) and McDonald’s Corp (NYSE: MCD) have even issued dim sum bonds.
Source: Hong Kong Monetary Authority
Dim sum bonds are mostly shorter-term in duration–between one to three years–because the insurance industry is not a big investor in the market yet. Insurers are the main driver of long duration bonds since insurers typically invest in long-dated bonds to better match their liabilities.
Instead, banks comprise roughly 70 percent of the investors in the dim sum bond market. However, this is gradually changing now that China has granted these investors limited access to its domestic bond market. The Peoples Bank of China (PBoC) now allows foreign central banks, RMB clearing banks and cross-border RMB trade settlement participating banks to invest in its onshore interbank bond market.
This allows these institutions to directly access the much deeper USD4 trillion domestic Chinese bond market. As bank participation in the dim sum market declines, mutual funds, individual investors, corporations and insurance companies from all over the world should step in to fill the void.
Additionally, the dim sum market has the full sanction of the Chinese leadership, including Li Keqiang, the vice premier of China’s State Council and the most likely successor to Premier Wen Jiabao. In a recent speech, Mr. Li indicated that plans are being formulated to facilitate onshore investment of RMB funds. Presently, the RMB is not a fully convertible currency, so the dim sum bond market provides greater ease in channeling funds back to the mainland.
There are two ways in which companies move funds to the mainland via the dim sum bond market: first as an inter-company loan to a mainland subsidiary, and second as an equity capital injection into a mainland subsidiary.
But this is still a slow process. For example, it recently took around three months for McDonald’s and Caterpillar to move their RMB bond proceeds onshore.
Although this new market presents opportunities for investors, risk must still be taken into consideration.
For instance, dim sum bonds behave very differently from onshore RMB bonds. Besides having lower yields, their prices often move in the opposite direction of domestic Chinese bonds.
Furthermore, CNH is an unregulated currency, so it fluctuates more than the RMB, which is regulated by daily central parity fixing within a narrow band. Finally, the offshore corporate bonds for Chinese companies are all structurally subordinated to onshore creditors.
On the other hand, the eventual appreciation of the RMB will reward investors, although the timing of this development is further away.
The preferred exchange-traded fund (ETF) for exposure to the dim sum market is PowerShares Chinese Yuan Dim Sum Bond Portfolio (NYSE: DSUM). This ETF tracks the Citigroup Dim Sum Bond Index, which includes government as well as private bond issues.
The largest position in the fund is a Chinese government bond maturing in 2016, with a coupon of 1.4 percent and an AA- rating from Standard & Poors.
Other holdings include: a bond issued by China Development Bank with a coupon of 2.7 percent, maturing at the end of 2013 and rated AA-; a Bank of China bond with a coupon of 2.9 percent, maturing in 2013 and rated A-; and a Caterpillar bond with a coupon of 1.35 percent, maturing in 2013 and rated A.
The ETF was launched this past September. It’s still quite small at just $3.6 million in assets, but we expect it to quickly grow in assets. The annual expense ratio is just 0.45 percent. And while the ETF hasn’t yet paid its first distribution, it should yield between 3 percent and 4 percent.
A play on an appreciating currency with an income kicker, PowerShares Chinese Yuan Dim Sum Bond is a buy under 26 in our Short-Term Opportunities Portfolio.