Dim Sum Bonds: A New Way to Play the Yuan and Chinese Debt
For about the last four months, investors have been throwing money into funds that focus on a relatively new instrument called "dim-sum" bonds. In fact, EPFR Global reported there were $81 million of inflows in the week ended January 16.
The big question: Is there a solid basis behind this movement, or are people out there just chasing yields?
First thing's first, what is a dim-sum bond?
Before you say it, it's not a bond investing in Chinese-style tapas cuisine.
A dim-sum bond is denominated in yuan but traded outside mainland China. These bonds look good to foreign investors who want exposure to yuan-denominated assets, but are hindered by the Chinese government's strict policies on investing in Chinese debt.
Who issues dim-sum bonds?
Usually, large companies based in China or Hong Kong and some big-time foreign companies issue the debt.
Dim-sum bonds began trading in 2009 when most investors believed it was a nice play to get exposure to the yuan, which they thought would appreciate. The idea was, if the Chinese currency appreciated, then the value of the bonds would rise.
But that pesky Chinese government had other ideas. For a period of time, the world has complained about how the Chinese have devalued their currency in order to come out on top of a dicey import/export game with the West.
Things really got interesting last year, when China's central bank decided on monetary policy to stunt the yuan's growth. The result was that dim-sum bond prices went into a tailspin.
Bonds101 teaches us that bond prices and yields have an inverse relationship. If one goes up, the other must go down. It makes sense. If the value of my bond has diminished, the yield must compensate.
Now the companies in the dim-sum market have no choice but to sell their bonds at higher yields, to compensate for an uncertain yuan. And investors have now started to flock to the market because of higher yields.
Now, let's see how those yields compare on an international scale...
Barclays reports the current average interest paid on recently issued corporate dim-sum bonds is around 4.25%. That outdoes our U.S. bond with the same maturities, which yield around 3.96%. Barclays also went on to say that dim-sum bonds have returned about 2% over the last three months.
More Than Just a Yield
This market is still pretty new but should see continued strong growth going forward. With rumors that the Chinese mainland could open up its own market, some think the offshore yuan market could be left on the sideline. It's widely known that the mainland's debt offers healthier yields.
But this market isn't only driven by yields. It's found favor because it offers diverse products and gives you a peace of mind in regulatory transparency and lack of restrictions - which mainland China's debt does not deliver.
And maybe the Chinese currency angle isn't dead yet…
The yuan is no longer the main attraction of dim-sum bonds, but the market could still be a play against the dollar and the euro.
The yuan hit a record intraday high earlier in January. Plus, it is forecasted to gain about 2% this year. This may seem to contradict what I said earlier but it doesn't.
The Chinese government keeps its currency within a narrow trading band. This lessens the risk of a sudden currency move that could hit your returns hard. The market knows it has to offer higher yields to get by, so any currency appreciation is an added extra.
However, there are reasons to be cautious.
Because the dim-sum market is small and newly established, yuan-denominated bonds trade less frequently than other denominated debt, like those in the West. That translates into the possibility of running into trouble if you're trying to find a buyer at a desired price.
Stay tuned as we learn more about these relatively new instruments…