Local bonds becoming more attractive to foreign investors

A low interest rate environment has made China's local bond market attractive to global investors. But careful scrutiny of individual corporate bonds is also essential, according to a leading global asset manager.

Ricardo Adrogué, head of emerging markets debt at Babson Capital Management, said the weaker growth is not necessarily a bad thing in the eyes of investors, because that could spur further rate cuts, which in turn could spark a rally in local bond sales.

"Should China open its onshore market, it's most likely I would increase exposure to it. But I would be more selective in which corporate names we picked," he said.

Babson has assets worth $223 billion under management.

Its current exposure to China is concentrated in US dollar-denominated bonds, issued by Chinese firms in overseas markets.

The emerging-market debt unit led by Adrogué also invests heavily in sovereign notes, but it lacks exposure to China because the country is yet to issue sovereign debt denominated in dollars or other hard currencies.

Babson is yet to apply for a quota to invest in China's onshore market, as Adrogué's operation was launched only two years ago and its focus has been on other emerging markets.

He said, however, it plans a stronger focus on the China market, after effectively becoming fully invested in other markets.

The company has about 8 percent of its portfolio in Chinese corporate bonds.

"Unlike the equity market, the debt market is directly related to monetary policy, which dictates interest rates," he said.

China's central bank cut headline interest rates recently for the sixth time since last November.

The consecutive series of rates cuts, and a lowering of the reserve requirement ratio, have seen money getting diverted from the equity market into the debt market, which has driven an unprecedented rally since August.

Adrogué said the Chinese economy is not overheated, and there is still room for further easing, and so the chances of a bond market bubble forming were slim.

"If prices fall, the government could ease policies to the point that almost forces them to back up," he said.

Despite the general optimism in the local market, he feared, however, that China's capital outflow has accelerated, with higher yields offshore pushing more Chinese investors to move their holdings into offshore debt.