An Analysis of Investment Value Of

Fixed Income Perspective

An Analysis of Investment Value of Dim Sum Bonds and Chinese US Dollar Bonds In the backdrop of China’s stock market crash, prevailing macroeconomic weakness and a lax monetary policy by the PBoC in 2015, the Chinese onshore bond market has experienced the longest bull run in history of more than 2 years. Ten-year China government bond yield fell drastically from 3.63% at the end of 2014 to 2.82% a year later. In contrast, offshore bond yields remain higher than the onshore bonds despite having been driven down by the latter. The PBoC auctioned one-year bills (Dim Sum bonds) aggregating RMB 5 billion at an average yield of 3.1% in London last October. This issue was oversubscribed five times and the yield-to-maturity was 40 basis points higher than onshore government bonds with the same maturity. Lower yields of domestic bonds have been resulting in narrowing of credit spreads and smaller carrying costs, giving rise to the expectation that the demand for offshore bonds with higher yields will continue to rise.

Value Analysis of Dim Sum Bonds Dim Sum bonds generally refer to offshore RMB bonds issued in Hong Kong. The market began to develop as early as in 2007 but Chinese financial institutions and sovereign entities were the only issuers, which limited the scale of the said market. The market had not changed dramatically until 2010 when the RMB started appreciating. Later restraints on issuers were gradually relaxed to allow companies worldwide to issue RMB-nominated bonds in Hong Kong, which triggered rapid growth of the Dim Sum bond market. Dim Sum bond yields used to be lower than onshore bonds of the same category since the appreciation of yuan was still in its early stages and the types of bonds available for investment were also relatively limited. The trend in yield-to-maturity of the 10-year government bonds shows that yields on onshore bonds have always been higher than offshore bonds until 2015. However, after China launched the Exchange Rate Regime Reform on August 11 2015, expectations of RMB devaluation and concerns about liquidity in the offshore market drove Dim Sum bond yields up, widening the spread between onshore and offshore bonds of the same category. As a result, Dim Sum bonds have recaptured the attention of investors in the light of the higher yields.

10Y Treasury Bond Yield Comparison 5 4.5 4 3.5 3 2.5 2 1.5 1 0.5 0 5/3/2011 5/3/2012 5/3/2013 5/3/2014 5/3/2015 5/3/2016 Onshore Treasury Bond Dim Sum Treasury Bond

Source：Bloomberg, Data as of 3/5/2016

Yield Comparison: Onshore Bonds vs. Dim Sum Bonds Onshore Bonds Dim Sum Bonds Spread Issuer Securities Name Maturity YTM (Mid) Securities Name Maturity YTM (Mid) (bps)

Hainan Airlines 15 海南航空 MTN001 2.48 5.3 HAIAIR 6 1/4 05/22/17 1.07 6.55 125 Bank of China 14 中行二级 8.29 3.83 BCHINA 4.15 06/30/25 9.17 4.15 32 Bank of Communications 14 交行二级 01 8.31 3.89 BOCOM 4 12/04/24 8.61 4 11 China Construction Bank 15 建设银行二级 01 9.65 3.93 CCB 4.08 11/18/24 8.56 4.32 39 China Minsheng Banking 12 民生 01 0.8 3.09 CHIMIN 0 12/14/16 0.63 3.99 90 China CITIC Bank 16 中信 CD109 1 3.09 CINDBK 4 1/8 02/27/17 0.84 3.86 77 China Development Bank 08 国开 09 12.12 3.57 SDBC 4 1/2 11/13/28 12.55 4.33 76 Sinochem Group 12 中化股 MTN1 0.96 3.15 SINOCH 3.55 05/13/17 1.04 4.06 91 Lenovo Group 11 联想债 2.51 3.62 LENOVO 4.95 06/10/20 4.12 4.87 125

Founder Group 12 方正 MTN1 2.86 3.91 PKFOUN 5 7/8 01/15/17 0.72 6.1 219 Guotai Junan Securities 13 国君债 1.2 3.82 GUOTJU 4.1 07/27/17 1.25 3.47 -35

State Power Investment 14 中电投 MTN002 1.3 3.13 CHIPOW 4 1/2 05/09/17 1.03 4.36 123 Beijing Jingneng Clean 12 京能 02 1.18 3.11 BJASST 4.3 12/23/17 1.66 4.43 132 Energy Power Construction Corp of 12 中水电 MTN2 1.24 3.22 CHPWCN 4.2 05/15/17 1.05 4.32 110 China Tianjin Eco-City Investment 16 生态城投 MTN001 2.89 4.31 TEIDEC 4.65 10/29/18 2.51 4.24 -7 & Development China Merchants Group 10 招商局 MTN1 1.59 3.26 CHMERC 3 06/30/16 0.18 3.82 56 HNA Group 09 海航债 3.66 5.87 SANYPH 8 11/13/17 1.55 10.89 502 Beijing Capital Group 14 首创 MTN002 1.56 3.48 BEICAP 4.7 06/20/17 1.15 4.64 116

China Minmetals 11 五矿 MTN1 0.54 3.74 MINMET 4 1/4 06/16/17 1.14 4.54 80 China City Construction 12 中城建 MTN2 1.64 3.79 CHICIT 5.35 07/03/17 1.18 11.49 770 Beijing Capital Land 15 首置 01 4.08 4.09 BJCAPT 6 7/8 02/17/19 2.81 6.74 265 China Vanke 14 万科 MTN001 1.66 3.39 VANKE 4 1/2 12/04/18 2.6 4.64 125 Longfor Properties 15 龙湖 02 4.25 3.78 LNGFOR 6 3/4 05/28/18 2.08 5.86 208 Fantasia Holdings Group 15 花样 02 4.67 7.17 FTHDGR 10 3/4 01/22/20 3.74 9.34 217 Export-Import Bank of China 12 进出 09 1.2 2.93 EXIMCH 3.35 06/18/17 1.14 3.68 75 People's Republic of China 12 附息国债 09 6.07 2.93 CGB 3.1 06/29/22 6.17 3.59 66 Source：Bloomberg, Wind, Data as of 3/5/2016

Value Analysis of China US Dollar Bonds On the contrary, the market for USD-denominated bonds in Asia has been around for a considerably longer period of time and, consequently, is a relatively more mature market. Compared to the Dim Sum bond market, the Asian US dollar bond market is more diverse in terms of size, maturity distribution and credit ratings while having higher liquidity. More than half of the US Dollar bonds issued in Hong Kong are issued by Chinese entities. Generally speaking, given the same rating and maturity, bonds issued in US dollars by Chinese entities have had higher yields compared to other Asian US dollar bonds, which presents an attractive investment opportunity for investors familiar with Chinese enterprises. At the same time, global economic growth has slowed down since the second half of the last year. Yields of government bonds of some economies have reached new lows with Japan announcing the introduction of negative interest rates earlier this year. In contrast, although China's economic growth has stalled, it continues to outperform several major economies by a wide margin and the majority of investors remain optimistic about its long-term investment value. RMB is currently going through a weak phase, the relatively stable Chinese US dollar bonds hold additional value to investors.

Asian 5Y Corporate Bonds 900 CN CENCHI 21 800 HK IN ID 700 MY SG 600 KR

COGARD 21 500

CARINC 21

400

Spread (bps)

- Z 300 CHJMAO 21 WEICHA 20 CHJMAO 21 CHOHIN 20 HRAM 20 XINAOG 21 SINOCH 20 CHIOLI 20 200 CNPCCH 21 CITPAC 21 BEIENT 21 CNOOC 21 CHCONS 20 ICBCIL 20 BCHINA 21 GUAMET 20 EXIMCH 20 ICBCAS 20 100 SDBC 20 AGRBK 20

0 AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB-

Source：Bloomberg, Data as of 3/5/2016

Yield Comparison: Onshore Bonds vs. USD Bonds Onshore Bonds USD Bonds Spread Issuer Securities Name Maturity YTM (Mid) Securities Name Maturity YTM (Mid) (bps) Hainan Airlines 15 海南航空 MTN001 2.48 5.3 HAIAIR 3 5/8 02/07/20 3.78 2.84 -246 Geely Automobile 16 吉利 MTN001 2.88 4.11 GEELY 5 1/4 10/06/19 3.44 4.07 -4 Weichai Power 16 潍柴控股 MTN001 4.88 4.37 WEICHA 4 1/8 09/30/20 4.43 3.67 -70 Bank of China 14 中行二级 8.29 3.83 BCHINA 5 11/13/24 8.55 4.53 70 Bank of Communications 14 交行二级 01 8.31 3.89 BOCOM 4 1/2 10/03/24 8.44 3.95 6 China Construction Bank 15 建设银行二级 01 9.65 3.93 CCB 3 7/8 05/13/25 9.04 3.74 -19 China CITIC Bank 16 中信 CD109 1 3.09 CINDBK 0 05/19/17 1.06 1.73 -136 China Development Bank 08 国开 09 12.12 3.57 SDBC 0 05/24/27 11.07 4.76 119 Yanzhou Coal Mining 12 兖煤 02 6.24 5.53 YZCOAL 5.73 05/16/22 6.05 7.56 203 Lenovo Group 11 联想债 2.51 3.62 LENOVO 4.7 05/08/19 3.03 2.86 -76 Founder Group 12 方正 MTN1 2.86 3.91 PKFOUN 5 1/2 06/05/18 2.11 4.74 83 China CITIC Bank 13 中信 01 2.11 3.48 CITICS 2 1/2 05/03/18 2.02 2.34 -114 Beijing Jingneng Clean Energy 12 京能 02 1.18 3.11 BJASST 2 3/4 02/26/17 0.84 1.94 -117 State Grid Corp of China 07 国网债 02 6.36 3.77 CHGRID 3 1/8 05/22/23 7.07 2.94 -83 JinkoSolar Holding 13 晶科债 2.76 10.6 JKS 4 02/01/19 2.77 6.57 -403 HNA Group 09 海航债 3.66 5.87 SANYPH 8 1/8 12/03/18 2.6 7.62 175 China Merchants Group 14 招商局 MTN001 5.31 3.8 CMHI 5 05/04/22 6.02 3.11 -69 China Taiping Insurance Group 14 太保债 7.86 4.29 CTIH 4 1/8 11/21/22 6.57 3.43 -86 Ping An Insurance Co of China 11 平安债 5.42 3.56 PINANI 2 7/8 01/19/21 4.73 2.68 -88 Beijing Capital 14 首创 MTN002 1.56 3.48 BEICAP 4.2 04/23/18 1.99 1.95 -153 China National Petroleum 12 中石油 03 2.82 3.38 CNPCCH 2 3/4 05/14/19 3.04 2.17 -121 Beijing Capital Land 15 首置 01 4.08 4.09 BJCAPT 7 1/8 12/02/49 33.6 9.91 582 Longfor Properties 15 龙湖 02 4.25 3.78 LNGFOR 6 7/8 10/18/19 3.47 5.14 136 Fantasia Holdings Group 15 花样 02 4.67 7.17 FTHDGR 10 3/4 01/22/20 3.74 9.34 217 Central China Real Estate 16 建业 01 4.96 6.58 CENCHI 8 3/4 01/23/21 4.74 8.34 176 CIFI Holdings Group 15 旭辉 02 4.54 5.58 CIFIHG 7 3/4 06/05/20 4.11 6.25 67 Evergrande Real Estate Group 15 恒大 02 3.2 4.64 EVERRE 8 01/15/19 2.72 8.66 402 Longfor Properties 16 龙湖 03 5.85 3.86 LNGFOR 6 3/4 01/29/23 6.76 5.56 170 MOY International 14 深茂业 MTN001 0.83 3.86 MAOIH 7 3/4 05/19/17 1.06 13 914 Beijing Infrastructure 14 京投 01 3.56 4.71 BEIJII 3 1/4 01/20/20 3.73 2.81 -190 Investment Source：Bloomberg, Wind, Data as of 3/5/2016

Relative Value Analysis Unlike Dim Sum bonds, yields of Chinese US dollar bonds are not significantly higher than onshore bonds of the same category. However, high-yield US dollar bonds remain appealing to investors at large. When US dollar bonds are hedged against variations in foreign exchange rates, yields-to-maturity in RMB is more attractive, based on the principle that interest parity implies absence of arbitrage opportunities. A risk-free RMB income portfolio consisting of US dollar bonds can be achieved by holding end positions in US dollar bonds together with exchange rate derivatives of same maturities to hedge against foreign exchange risk. Currently available foreign exchange derivatives can be roughly classified into three types, namely, currency swaps, foreign exchange futures and forward foreign exchange, all of which carry similar implied hedging costs. Backwardation of RMB forward rates implies that US dollar bonds carry an additional 2.31% return by locking foreign exchange rates.

Hedging Return: CNH 1Y Forward Premium Rate

6.00%

5.00%

4.00%

3.00%

2.00%

1.00%

0.00%

-1.00%

-2.00% 8/23/2010 8/23/2011 8/23/2012 8/23/2013 8/23/2014 8/23/2015 Source：Bloomberg, Data as of 3/5/2016

When comparing the value of Chinese issued Dim Sum bonds with remaining maturity of one year to comparable US dollar bonds, the yield of the latter and the respective backwardation of foreign exchange forward rates need to be added for calculating the equivalent rate of return in RMB. As indicated in the chart below, investment-grade US dollar-denominated bonds broadly offer RMB yields similar to Dim Sum bonds on average, while high-yield bonds can offer return higher than even Dim Sum bonds. In addition, a RMB portfolio consisting of foreign exchange derivatives has two advantages. First, the size and liquidity of the US dollar bond market dwarf that of Dim Sum bonds, which implies drastically greater depth of the market. Moreover, since the remaining maturities of Dim Sum bonds are generally shorter and primary issuance is limited, US dollar bonds are often issued with maturities that are determined on the basis of demand in the market. In general, a RMB portfolio consisting of US dollar bonds and foreign exchange derivatives should generate higher investment value for Dim Sum bond investors.

1Y Dim Sum Bonds and USD Bonds (CNY Return) Yield Comparison 14 USD Bonds (CNY return) 12 Dim Sum Bonds

0 AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- Source：Bloomberg, Data as of 3/5/2016

Yields Comparison: Onshore Bonds vs. USD Bonds (CNY Return) Onshore Bonds USD Bonds (CNY Return) Spread Issuer Securities Name Maturity YTM (Mid) Securities Name Maturity YTM (Mid) (bps) Hainan Airlines 15 海南航空 MTN001 2.48 5.3 HAIAIR 3 5/8 02/07/20 3.78 5.14 -16 Geely Automobile 16 吉利 MTN001 2.88 4.11 GEELY 5 1/4 10/06/19 3.44 6.37 226 Weichai Power 16 潍柴控股 MTN001 4.88 4.37 WEICHA 4 1/8 09/30/20 4.43 5.97 160 Bank of China 14 中行二级 8.29 3.83 BCHINA 5 11/13/24 8.55 6.83 300 Bank of Communications 14 交行二级 01 8.31 3.89 BOCOM 4 1/2 10/03/24 8.44 6.25 236 China Construction Bank 15 建设银行二级 01 9.65 3.93 CCB 3 7/8 05/13/25 9.04 6.04 211 China CITIC Bank 16 中信 CD109 1 3.09 CINDBK 0 05/19/17 1.06 4.03 94 China Development Bank 08 国开 09 12.12 3.57 SDBC 0 05/24/27 11.07 7.06 349 Yanzhou Coal Mining 12 兖煤 02 6.24 5.53 YZCOAL 5.73 05/16/22 6.05 9.86 433 Lenovo Group 11 联想债 2.51 3.62 LENOVO 4.7 05/08/19 3.03 5.16 154 Founder Group 12 方正 MTN1 2.86 3.91 PKFOUN 5 1/2 06/05/18 2.11 7.04 313 China CITIC Bank 13 中信 01 2.11 3.48 CITICS 2 1/2 05/03/18 2.02 4.64 116 Beijing Jingneng Clean Energy 12 京能 02 1.18 3.11 BJASST 2 3/4 02/26/17 0.84 4.24 113 State Grid Corp of China 07 国网债 02 6.36 3.77 CHGRID 3 1/8 05/22/23 7.07 5.24 147 JinkoSolar Holding 13 晶科债 2.76 10.6 JKS 4 02/01/19 2.77 8.87 -173 HNA Group 09 海航债 3.66 5.87 SANYPH 8 1/8 12/03/18 2.6 9.92 405 China Merchants Group 14 招商局 MTN001 5.31 3.8 CMHI 5 05/04/22 6.02 5.41 161 China Taiping Insurance Group 14 太保债 7.86 4.29 CTIH 4 1/8 11/21/22 6.57 5.73 144 Ping An Insurance Co of China 11 平安债 5.42 3.56 PINANI 2 7/8 01/19/21 4.73 4.98 142 Beijing Capital 14 首创 MTN002 1.56 3.48 BEICAP 4.2 04/23/18 1.99 4.25 77

China National Petroleum 12 中石油 03 2.82 3.38 CNPCCH 2 3/4 05/14/19 3.04 4.47 109 Beijing Capital Land 15 首置 01 4.08 4.09 BJCAPT 7 1/8 12/02/49 33.6 12.21 812 Longfor Properties 15 龙湖 02 4.25 3.78 LNGFOR 6 7/8 10/18/19 3.47 7.44 366

Fantasia Holdings Group 15 花样 02 4.67 7.17 FTHDGR 10 3/4 01/22/20 3.74 11.64 447 Central China Real Estate 16 建业 01 4.96 6.58 CENCHI 8 3/4 01/23/21 4.74 10.64 406 CIFI Holdings Group 15 旭辉 02 4.54 5.58 CIFIHG 7 3/4 06/05/20 4.11 8.55 297 Evergrande Real Estate Group 15 恒大 02 3.2 4.64 EVERRE 8 01/15/19 2.72 10.96 632 Longfor Properties 16 龙湖 03 5.85 3.86 LNGFOR 6 3/4 01/29/23 6.76 7.86 400 MOY International 14 深茂业 MTN001 0.83 3.86 MAOIH 7 3/4 05/19/17 1.06 15.3 1144 Beijing Infrastructure 14 京投 01 3.56 4.71 BEIJII 3 1/4 01/20/20 3.73 5.11 40 Investment Source：Bloomberg, Wind, Data as of 3/5/2016

Jeffery Qi, Portfolio Manager Fixed Income Team, E Fund Management (HK) Co. Limited E Fund HK Disclaimer:

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