Chinese bond market: Chinese investors are increasingly turning to convertible bonds amidst record low yields in the domestic debt market and uncertainty surrounding equities, finding these hybrid instruments an appealing compromise in the current financial landscape.

Bond yields on yuan-denominated government and corporate debt have experienced significant declines over the past year, driven by expectations of monetary stimulus to bolster a slowing economy, which has also weighed on the stock market.

The flight to safety in bonds has driven 10-year yields down by over 30 basis points (bps) this year, marking their lowest levels in more than two decades.

As a result, some bond investors are redirecting their focus towards convertible bonds, which offer relatively attractive pricing for potential conversion to equities while still providing a coupon like regular bonds.

Convertible bonds, being hybrid securities, possess a conversion option to the issuing company's stock, resulting in generally lower yields compared to traditional bonds.

Data from LSEG indicates that approximately 30 per cent of onshore convertible bonds offer yields to maturity exceeding 2.5 per cent, equivalent to the current trading level of three-year AA-rated corporate bonds

Analysts attribute this attractiveness partly to limited demand from pension funds and other institutional investors, which helps maintain the affordability and high yields of convertible bonds.

Wei Li, portfolio manager at BNP Paribas Asset Management, said, "The risk-reward ratio for convertible bonds is currently at its highest level since 2021. Median bond prices have increased marginally, while premium rates have compressed significantly, indicating improved bond-stock properties."

With traditional sources of mainland high-yield assets such as property bonds and local government financing vehicle (LGFV) bonds facing regulatory constraints, investors are increasingly eyeing convertible bonds as viable alternatives.

By holding convertible bonds, investors also stand to benefit should the stock market rebound.

Su Jiangning, senior product manager at Shanghai Hesheng Assets Management, commented, "We recently increased our holdings in convertible bonds. Straight bond yields have dropped across the board so comparatively convertible bond return could be more attractive due to low valuation of the embedded option. Some implied option value is even close to zero."

While the CSI Convertible Index has remained relatively flat this year, slightly underperforming the blue-chip CSI300 index, Xia Huadong, institutional business director at Riturn Asset Management in Shanghai, believes that select low-rated convertible bonds present intriguing opportunities.

"Our strategy is to select convertible bonds with both low prices and low premium rate, providing these securities with a larger scope for future price appreciation," he explained.

(With Reuters inputs.)