China has had 22 bond defaults year-to-date, exceeding the 21 defaults reported for all of 2015. However, Lunt dismissed concerns and said that higher default rates are healthy for the market rather than a trigger for a systemic crisis.
“There are going to be a lot of bumps in the road," Lunt told FSA. "A lot of the schemes, such as the conversion of local government financing vehicles into municipal securities, frightens people in the short term, but it is a necessary development.
“These developments can affect the prices in the short term, and can cause some volatility, and they are important to be aware of. But they should be seen as a net positive because it’s a further sign of development."
He said the reasons to consider China sovereign bonds in a global sovereign bond portfolio include yield, diversification, interest rates and currency.
The challenge, however, would be low quality credit, where visibility is hard and evaluation requires more specialist knowledge or a local market presence.
Lunt added that being selective is the key. For example, although some municipal bonds are high quality, "we might not buy municipal bonds at the moment because they are very expensive".
Weak foreign interest
China is expected to open its interbank bond market, which Lunt believes will become the investment channel used by most investors. “It seems to be a great simplification of any previous schemes, and pretty straight forward.”
The proposed scheme, announced in February this year, is to open the onshore interbank bond market to “long-term” foreign investors with no quota restrictions and streamlined regulations, meaning they don’t need to go through the existing qualified foreign institutional investor (QFII) programme, which has quota limits.
It is uncertain when the interbank bond scheme will begin.
China also plans a "bond connect" similar to the stock connect scheme, but Lunt says it will be more for the exchange-traded market, which he said is smaller than the interbank market.
He said Asian investors have had a strong interest in the onshore bond market and believes global investors are warming to it as well.
Foreign investors only owned about 3% or $105bn of local Chinese bonds at the end of 2014, Lunt said, citing the latest available figures from a JP Morgan study.
“It is quite a clever timing [for China to open up the onshore market],” he said, as the higher yield offshore market means “they can begin to open access without a flood of money coming in. The appetite will be steady, but won’t be a deluge.”
Ultimately, he believes the onshore bond market will be included in global bond indices. If that happens, investing in China would be "a fact of life for global investors," he said.
A 10% foreign participation would translate to about $50bn of new inflow, he said, although he did not have an estimate of when that could happen.