KCCBFixed Income

Fund Focus: KraneShares CCBS China USD High Yield Corporate Bond Index ETF (Ticker: KCCB)

Harbin, China’s Famous Ice & Snow World Festival park with illuminated ice sculptures and structures.

In today’s market, investors are desperately searching for yield. Foreign investors have historically overlooked China’s bond market despite its historically attractive real yields and potentially lower risk compared to both developed and emerging economies. Although current foreign ownership of the Chinese bond market is still low at only 3%3 of the total market, it is actually at an all-time high. This rise has been facilitated by easier access through the Bond Connect program and the recent addition of Chinese bonds to global bond indexes. Current active and passive exposures to the global bond market may fail to reflect China’s size and importance in a global context. We believe adding a China bond exposure has the potential to improve yield and lower risk given the market’s low correlation with global bond and equity markets and attractive risk profile.

The KraneShares CCBS China Corporate High Yield Bond ETF (Ticker: KCCB) offers investors exposure to China’s offshore USD-denominated high yield bonds, which are benefiting from the increased flows and recognition of the overall China bond market. As of 9/30/2019, the fund offered a yield to maturity of 6.17%, a modified duration of 1.84 years, and an average 3-year default rate of 1.97%1.

The China USD high yield offshore bond market offered an attractive real (inflation-adjusted) yield as of 9/30/2019 that is among the highest in Asia and Emerging markets.

Data from JP Morgan as of 9/30/2019. Asia bond data from the JP Morgan CEMBI Index.*Real Yield = yield-inflation.
Index performance is for demonstrative purposes only. Indexes are unmanaged and do not reflect management fees or any costs involved in investing. One cannot invest directly in an index. Past performance does not ensure future returns.

The projected default rate of the Chinese bond market is the lowest compared to global high yield markets. Despite higher debt levels among corporates in China, the government has been able to manage the credit cycle without any significant issues.

Data from JP Morgan as of 7/31/2019, EM bond data from the JP Morgan CEMBI Index.
Index performance is for demonstrative purposes only. Indexes are unmanaged and do not reflect management fees or any costs involved in investing. One cannot invest directly in an index. Past performance does not ensure future returns.

The strong profile of the Chinese bonds market is reflected in the KCCB ETF, which has offered attractive returns for a lower duration, a measure of interest rate risk, compared to many global bond indexes.

Data from JP Morgan as of 9/30/2019. Asia bond data from the JP Morgan CEMBI Index.*Real Yield = yield-inflation.
The fund’s full prospectus and standard performance as of the most recent calendar month end is available here.

China’s offshore high yield bond market has exhibited a lower correlation to emerging market and global bond indexes.

Weekly Correlation data over the past year (2019) from Bloomberg.

As a result, an efficient frontier analysis suggests that adding a USD denominated China High Yield Bond exposure to a USD-denominated Emerging Market Bond portfolio may help improve investors’ risk-return profile. The optimal portfolio over the past five years would have been 38% China HY and 62% EM Bond.

Data from Bloomberg as of 9/30/2019.

According to Morningstar, exposure to Chinese bonds in both the active and passive emerging markets debt universes is low and not reflective of China’s size. The passive emerging markets bond hard currency universe, which includes 18 ETFs, has an average exposure of 6.96%, and only three ETFs with an exposure of more than 10%. The exposure of the active emerging markets bond universe (82 funds) is even lower and stands at 2.92%.2 Apart from a couple of Asia bond Funds, very few funds have any meaningful exposure to China’s bonds.


Source Morningstar: passive data is as of 9/30. Active data is as of 6/30/2019. China’s Share of World Economy is from Bloomberg.

China’s yield curve exhibits a normal shape and slopes upwards, compared to other countries, especially the U.S., where the yield curve has inverted.

Data from Bloomberg as of 9/30/2019

China has one of the highest credit ratings in the world. China’s A1 sovereign rating is equivalent to that of Japan and one notch below that of the U.S.

Data from Bloomberg as of 9/30/2019

An attractive real yield, a liquid market, and an improved risk profile have the potential to make China’s USD-denominated offshore bond market a reliable source of yield for global investors. Debt obligations under the ETF are also dollar-denominated, and thereby mitigate currency risk. The resiliency of the Chinese economy gives us some confidence that in the event of a global slowdown, the Chinese government would be able to support its economy through stimulus and effective policies.


Citations

  1. Data from Bloomberg as of 9/30/2019
  2. Data from Morningstar as of 9/30/2019
  3. Shu, Chang. “China’s bond market is too-big-to-ignore,” Bloomberg Professional Services. April 18, 2019.

Moody’s Sovereign Credit Ratings are measured on a scale that generally ranges from Aaa (highest) to C (lowest),

Term Definitions

The KraneShares ETFs are distributed by SEI Investments Distribution Company (SIDCO), 1 Freedom Valley Drive, Oaks, PA 19456, which is not affiliated with Krane Funds Advisors, LLC, the Investment Adviser for the Fund, or China Construction Bank (CCB), or E Fund. R_KS_SEI

Yield-to-Worst (YTW) – the lowest potential yield that can be received on a bond without the issuer actually defaulting.

Sharpe Ratio – the average return earned in excess of the risk-free rate per unit of volatility or total risk.

Yield-to-Maturity (YTM) – the total return anticipated on a bond if the bond is held until it matures.

Default Probability – the likelihood over a specified period, usually one year, that a borrower will not be able to make scheduled repayments.

Yield Difference (Yield Spread) – the difference between yields on differing debt instruments of varying maturities, credit ratings and risk, calculated by deducting the yield of one instrument from another.

Modified Duration (Mod Duration) – the measurable change in the value of a security in response to a change in interest rates. This formula is used to determine the effect that a 100-basis-point (1 percent) change in interest rates will have on the price of a bond.

Index Definitions

Solactive USD China Corporate High Yield Bond Index – seeks to track the performance of outstanding high yield debt securities denominated in U.S. dollars issued by Chinese companies. Inception date is 7/10/2018.

CSI Diversified High Grade Commercial Paper Index – tracks a diversified basket of investment-grade commercial paper denominated in onshore renminbi and issued by sovereign, quasi-sovereign and corporate issuers in the People’s Republic of China and traded in the inter-bank bond market. Inception date is 11/05/2014.

The S&P 500 Index – an American stock market index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ. Inception date is 3/4/1957.

The MSCI Emerging Markets Index – captures large and mid cap representation across 23 Emerging Markets (EM) countries. With 834 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country. Inception date is 1/1/2001.

MSCI China Index – captures large and mid cap representation across China H shares, B shares, Red chips and P chips. With 157 constituents, the index covers about 84% of this China equity universe. Inception date is 10/31/1995.

S&P China BMI Index – a comprehensive benchmark that defines and measures the investable universe of publicly traded companies domiciled in China, but are legally available to foreign investors. Inception date is 10/31/1997.

US Generic Government 10 Year Index Yield – This index tracks the yield performance of 10-year treasury bills. Treasury bills are often used as a benchmark to represent a risk-free asset. Yields are yield to maturity and pre-tax. Indices have increased in precision as of 5/20/2008 to 4 decimal places. The rates are comprised of Generic United States on-the-run government bill/note/bond indices. 

Bloomberg Barclays US Aggregate Corporate Index Yield to Worst – This index tracks the yield to worst of corporate bonds in the United States. The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, fixed-rate agency MBS, ABS and CMBS (agency and non-agency). Inception date is 1/3/1989.

Bloomberg Barclays Euro Aggregate Corporate ISMA Index – The index is a rules based benchmark measuring investment-grade, Euro denominated, fixed rate, corporate bonds. Inception date is 8/3/1998.

Bloomberg Barclays Emerging Markets EMEA Index – This index tracks the yield to worst of bonds issued in emerging markets in Europe, the Middle East, and Africa. Inception date is 2/3/2006.

Bloomberg Barclays Corporate High Yield Index – The Bloomberg Barclays US Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. Inception date is 8/7/1998.

Bloomberg Barclays Asia USD Inv. Grade Bond Index – This index tracks the performance of Asian corporate bonds with an S&P rating of BBB- and/or a Moody’s rating of Baa3 or higher. Inception date is 5/22/2014.

Blomberg Barclays Asia USD High Yield Bond Index – This index tracks the performance of Asian junk bonds. The bonds tracked have a higher risk of default than investment grade bonds or may currently be in default. Inception date is 6/3/2014.

JP Morgan Corporate Emerging Markets Bond Index (CEMBI) – a market capitalization weighted index consisting of U.S. dollar denominated emerging market corporate bonds. Inception date is 11/8/2007.