Several years ago there was an ill-fated theme in the investment community of a ‘great rotation’ of investor capital out of government bonds and into equities. There is discussion once more about a great rotation, but now it is in China. One part of that rotation is the shifting of investors’ desire from owning property to owning financial assets, such as equities and bonds. In this post, we will review the Chinese household’s balance sheet, and look at how the various investment options available have performed.
Chinese savers overwhelmingly choose to place their savings in bank deposits, which have yielded, a negative 2.7% return over the past nine years. In the Survey of Household Finances conducted by the Southwestern University of Finance and Economics (SWUFE), fewer than 10% of respondents held stocks, less than 5% held investment funds, and less than 1% held bonds, derivatives, or other financial products. On the other hand, the urban homeownership rate, according to SWUFE, stands at nearly 90%, and 23% of households own more than one property.
We take a look at six broad assets that domestic investors have access to: bank deposits, equities, housing, wealth management products, government bonds, and corporate bonds. Looking at average one-year returns over five year periods, equities appear to be a clear outperformer (exhibit 1). But like we stated in a previous post, for many investors the volatility of returns is more important than the returns themselves. Taking snapshots of relative risk-adjusted returns, we show the Sharpe ratio for the six assets at three separate time periods. As shown in exhibit 4, on a risk-adjusted basis, property is clearly the best-performing asset class, with bank deposits bringing up the rear due to the negligible negative real return. The clear outperformance of property is even clearer if considering the major cities of Beijing and Shanghai (exhibit 3).
The median household therefore, faced with limited investment options, is incented to put the ≈40% of their disposable income that they’re saving into the property market. At the same time, just like their counterparts around the world, Chinese households have to consider not only the potential capital gains on their property, but also the net yield on the property. As in, what do they expect to pay in rent for a property, versus the mortgage rate (or foregone interest on savings) they would pay for the same property. If there were many alternative investment options available, the opportunity cost of purchasing property would be higher.
More recently, demand for more investment options has led to the proliferation of “wealth management products” which offer higher rates of interest over discrete time periods, though the offerings are still limited and have relatively high minimum investment requirements. According to SWUFE, the median household has zero debt and RMB 405k in total assets, of which RMB 400k are housing related. They found that the median household has just RMB 17k in financial assets, and the top 10% of households by net worth own over 60% of total financial assets. SWUFE also found that only 20% of households that invested in the equity market had positive returns, and 52% of respondents not investing cited a lack of understanding of the market as the reason.
With such strong income gains and a tightly controlled capital account, the estimated RMB 16 trillion in savings by households will continue to slosh around the domestic financial markets in search of the best yield. The authorities should continue their reform efforts in the financial sector and then continue to open up the capital account to relieve the domestic monetary pressure. Until then, financial markets in China will remain susceptible to over-exuberance.
Exhibit 1: Monthly rolling 5-year average of 1-year real returns
Source: Bloomberg, China National Bureau of Statistics (NBS), ChinaBond, author’s calculations
Exhibit 2: Real returns of various domestic asset classes (12/2006 = 100)
Source: Bloomberg, NBS, ChinaBond, author’s calculations
Exhibit 3: National real home price index vs. Beijing/Shanghai home prices
Source: NBS, author’s calculations
Exhibit 4: Measure of risk-adjusted return for various asset classes
Note: Not all previously listed assets have enough data history to allow for equal comparison (i.e. WMP’s and corporate bonds). Source: Source: Bloomberg, NBS, ChinaBond, PBoC, author’s calculations
Exhibit 5: Trends in equity and housing prices
Source: Source: Bloomberg, NBS, author’s calculations
 We use a market cap weighted aggregation of the Shanghai and Shenzhen indices. We also add in dividends for a total return. The bond indices are also on a total-return basis. We believe this, if anything, understates the outperformance of property relative to equities as our property measure only considers price appreciation and not income therefrom.
 Similar to our previous post, we created our own housing index. This time we took monthly aggregate housing sales by region and divided by floor space sold in those regions to get a per square meter price of property. Then we reaggregated to the national level.
 We acknowledge of course not all investors would have access to these assets for our entire sample period.
 We use the standard [(x̄p – xrf) / σp] formulation. For this, we use 5-year average of monthly 1-year returns for each asset minus that of the risk free asset, which we designate as bank deposit. The denominator is the standard deviation of the monthly one-year returns over the same 5-year period.
 Naturally, there is no property whose value performed as neatly as the national index and local property prices are likely slight more volatile.