01

In recent years, the Chinese market for index bond funds has experienced remarkable growthThe emergence of "asset scarcity" alongside declining interest rates has led institutions to seek opportunities in passive bond funds that offer both low risk and stable returnsAs investors face increasing challenges in traditional asset markets, passive index bond funds have become a focal point due to their transparent holdings and consistent strategiesUnlike actively managed bond funds that only disclose their top holdings periodically, index bond funds provide a clearer picture of their investment portfoliosAdditionally, the simplistic and systematic nature of index fund strategies—based on predetermined indexes—means that their transaction and management costs are typically lower.

Since the beginning of 2023, the overall scale of the index bond fund market soared from 476.9 billion yuan at the end of Q1 to 1.2874 trillion yuan by the end of 2024, marking an impressive growth of 170%. Within the broader pure bond fund space, the market share of index products has risen from 7% to 14%, illustrating a mounting institutional demand for these solutionsIn the initial phase of the index fund's development, interest-rate-related products have taken the lead, with rate-based index funds constituting 87% of all index bond fundsInterestingly, bank credit note index funds alone account for 12% of this segmentThe maturity distribution within various timeframes—34% in the 0-3 year bracket, 9% in the 3-5 years, and 10% in the 7-10 years—suggests a comprehensive alignment with market investment needsMoreover, the listing of the 30-year national treasury ETF at the beginning of 2024 has expanded investment options for long-term rates significantly.

Emerging as a novel asset class, credit bond index funds currently exist in a "blue ocean" of low liquidity and high growth

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Data from Wind indicate that by December 2024, the domestic credit bond index fund market was valued at 126.6 billion yuan across 27 funds, making up 10% of the total passive bond index fund marketWhen observing growth, the second and third quarters of 2023 witnessed the first surge of credit bond index fund investments, with annual growth rates of 32% and 21%, respectivelyThe second significant expansion occurred in Q2 of 2024, with a quarterly growth rate of an astonishing 65%, prompting total assets to exceed a billion for the first timeAlthough Q3 of 2024 saw some redeeming pressure on pure bond funds, the credit bond index funds recovered by year-end, achieving a 20% growth rate in Q4.

By examining examples from international markets, credit bond products represent crucial components in the indexing process of bond fundsA pertinent case is found in the United States, where index bond funds are primarily categorized into two broad groups: bond ETFs and passive mutual fundsThe bond ETF segment has exhibited remarkable growth, with assets rising from $4 billion in 2002 to $1.5 trillion by 2023. By year's end, bond ETFs made up 24% of the total in U.S. bond funds, while passive mutual funds maintained a steadier growth trajectory, sitting at 15%. This diversification also illustrates that while government and municipal bonds only encompass 12% and 17% of the bond fund market, the U.S. bond index primarily emphasizes credit-type products.

Reflecting upon the domestic index bond fund landscape, the credit bond index funds predominantly track indexes released by the China Bond Valuation Center and the China Securities Index Company, accounting for 75.7% of the total market share by the end of September 2024. The index investments mainly focus on medium to high-grade, medium to short-duration credit bonds.

From a categorization standpoint, these index funds can be grouped into seven major categories: comprehensive indexes, medium to high-grade credit, central SOEs, green finance, short-duration funds, custom strategies, and regional characteristics

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The comprehensive indexes, such as the new comprehensive index from the China Bond market, serve as broad baselines with a prevailing proportion held in rate securitiesNotably, products like E-Fund's new comprehensive index offerings tend to offer a passive approach to investment.

Meanwhile, medium to high-grade credit-type index funds have become focal points for various managers, constituting 30% of the total scale within credit index bond fundsThese products serve as valuable instruments, allowing investors to select suitable credit risk levels as per their requirements—be it investment-grade or higher AA categories in the outgoing bond market.

Analyzing the performance of credit bond index funds in 2024, there were 21 funds that achieved returns exceeding 3.0%, with an additional two ranging between 2.0% and 3.0%. While the annual returns were particularly attractive, the median maximum drawdown remained restrained at 0.59%, enabling 19 of these funds to attain a Calmar ratio of over 4.

On December 31, 2024, the eagerly awaited first batch of benchmark market-making corporate bond ETFs received approval, signaling an innovative upgrade to the bond ETF marketKey players like Bosera Fund, Dacheng Fund, Tianhong Fund, and Guangfa Fund were granted licenses for the Shenzhen benchmark market-making credit bond ETF, closely tracking the Shenzhen benchmark market-making indexLikewise, Southern Fund, E-Fund, Huaxia Fund, and Haifutong Fund received approval for the Shanghai benchmark market-making corporate bond ETF, targeting the corresponding Shanghai benchmark.

Analyzing the component securities of these indices reveals a focus on state-owned enterprises and high-rating entities, primarily within the 3-5 year duration rangeSpecifically, the Shanghai market-making corporate bond index comprises 184 securities from 64 issuers, while the Shenzhen index encompasses 217 securities across 77 issuers, predominantly state-owned enterprises rated AAA

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The average remaining durations on these bonds are approximately 4.67 and 3.49 years, respectively, with a significant majority displaying remaining exercise periods extending beyond three years.

From a functional standpoint, these benchmark market-making corporate bond ETFs exhibit a heightened aggressiveness that enhances the yield elasticity of index bond fund portfoliosAn evaluation from early July 2022 to the present illustrates that the total return on the Shenzhen market-making credit index has reached 10.78%, yielding an annualized rate of 4.16%, while the Shanghai corporate bond index has stabilized at a total return of 11.54%, equating to an annualized rate of 4.45%. Both indices yield results that sit between implied AA+ credit wealth indices over varied timeframes of 3-5 years and 1-3 years, outperforming the Wind online short-term and medium to long-term bond indicesFrom a drawdown perspective, the maximum drawdown observed since July 2022 has been 0.97% for the Shenzhen index and 1.30% for the Shanghai index—levels comparably lower than the observed 1.08% of the medium to long-term Wind index, but considerably beneath the implied AA+ rates of 2.41% for the 3-5 year frame and 1.77% for the 1-3 year period.

Additionally, given the distinctive functional nature of credit indices, a hypothetical investment scenario lasting for a quarter signals a maximum rolling three-month yield of 2.00% for the Shenzhen index, with a standard deviation of 0.65%, while the Shanghai corporate bond index reaches an impressive rolling yield of 3.32%, accompanied by a volatility trace of 0.69%. Thus, while showcasing attractive upper yields, the uncertainty remains at neutral ranges.

In conclusion, both the Shenzhen and Shanghai benchmark market-making corporate bond ETFs present compelling returns with manageable risks, particularly in light of the current limited availability of credit bond ETFs, indicating a bright outlook for the future expansion of these products.

02

Completing the Tooling

Refinement of Bond ETF Rotation Strategies

Establishing rotation strategies necessitates that the participating assets exhibit minimal overlap while collectively covering an exhaustive range of assets. "Minimal overlap" refers to assets having dissimilar performance; thus, when one asset underperforms, others in the sample continue to provide safety for trades, which consequently keeps the strategy's drawdown manageable. "Comprehensively exhaustive" denotes a sample that encompasses virtually all asset types to ensure that in various environmental conditions, robust assets will always be represented within the sample, thereby enhancing the strategy's return elasticity.

Following the maturation of bond ETF products, the traits of "minimal overlap" and "comprehensive coverage" further crystallize, leading to refined rotation strategies

Specifically, convertible bond ETFs allow strategies to mitigate risks during downturns in pure bonds while capitalizing on rallies within equity markets; short-duration pure bonds can serve as defensive maneuvers amid marginal adjustments in the bond market, while mid-duration credit bonds can offer cost-effective options during market lateral phasesUltra-long-rate bonds strategically exploit yields from pure bond assets during bull marketsGuided by this rotation ideology, we propose the following bond ETF rotation strategy:

Examining existing bond ETFs reveals that Bosera Fund covers all aforementioned asset classifications, particularly excelling in short-rate, ultra-long-rate, and convertible bond ETFs that have appropriate scales and liquidity for use as categorized samples within the bond ETF allocation strategyThe inclusion of 3-5 year credit bond ETFs enhances the diversity of assets available for rotational participation.

2.1. Convertible Bond Allocation: Optimal in accommodating Loose Monetary and Broad Credit Environments

In our examination, the nature of convertible bond ETFs displays distinct characteristics: their performance closely aligns with equities, unlike other pure bond ETFs that primarily track debt market trendsConsequently, the timing of their selection requires a framework that considers broader "equity-bond rotation". Our earlier analysis titled "Understanding the Monetary-Credit Framework" introduces methods for classifying asset types using this monetary-credit structureNarrow liquidity (base currency) and broad liquidity (credit generation) delineate four economic cycle phases: monetary easing with credit tightening, monetary easing with credit broadening, monetary tightening with credit broadening, and monetary tightening with credit tighteningOur review has segmented the monetary-credit dynamics since 2016.

In a monetary easing and broadening credit environment, allocating convertible bonds is optimal

Across the monetary-credit framework's phases, asset performances vary while optimal allocation opportunities emergeBy embedding the performance of the CSI Convertible Bonds against the broader composite bond indexes, we observe that during periods of monetary easing and credit broadening, convertible bonds reap substantially higher returns than equivalent broader bond composites, while they appear comparable or weaker in other scenariosThis clearly indicates that the convertible bond allocation is most favorable under loosening monetary and expanding credit conditions.

2.2. Pure Bond Rotation: Duration Strategy based on Bond Market Trends

In the remaining three monetary-credit environments, pure bonds generally outperform convertible bondsHowever, the plethora of pure bond ETF options each vary significantly in their characteristicsFor example, ultra-long interest rate bonds have shown robust growth recently but come with higher volatility, making them less attractive during periods of significant market pullbacksIdentifying superior asset classes during various timeframes assiduously drives the creation of efficient pure bond rotation strategiesTo address this, we will categorize the pure bond landscape into three distinctive phases: "strengthening", "consolidating," and "pulling back". During strengthening phases, ultra-long term rates should be utilized to optimally harness bull market gainsWhen the market enters a consolidation phase, 3-5 year credit bonds are likely more attractive, while in a recession phase, short-duration interest rate bonds will enhance the strategy's resilience.

Nonetheless, practical execution poses challenges for investors attempting to ascertain current market standingsTo address this, the strategy suggests using ultra-long-rate bond ETFs as the foundational aspect of pure bond rotation while monitoring market trends for positional adjustments

On one hand, the transition in a broad monetary direction appears minimal, supporting that ultra-long bonds should retain attractive yield characteristics; on the other hand, since July 2022, these long-duration bonds have consistently outperformedOver a total of 31 months up to January 2025, ultra-long duration bonds showed superiority in 21 months, indicating their suitability as the foundation for pure bond rotation strategyThe allocation between 3-5 year credit bonds and short-term interest bonds should flexibly adjust as market conditions evolve.

Since the foundation date of the Shenzhen benchmark market-making credit index is set as June 30, 2022, the revised rotation strategies begin their practical discussions from July 2022. Importantly, given the incremental growth in social financing by December 2024 and the inception of broad credit signals, we will delay the convertible bond allocations until January 2025 as investors await concrete dataAs guided by the outlined rotation ideology, our asset allocation strategy is as follows:

2.3. Enhanced Rotation Strategy to Augment Portfolio Yield

The configurations from earlier allocations will be back-tested against historical observations to form "ideal strategy" net value curvesRecognizing that investors require time to adapt to the shifts in monetary-credit landscape and bond market fluctuations, our "ideal strategy" retrogresses its allocation 10 trading days for the back-testing process, which results in retracing the net value curves for the "lagging strategy". Further, to create a control group for variances within the rotation strategies, we will weight various assets equally, deriving a net value curve for the equal-weight portfolio.

The enhanced rotation strategies indeed bolster return characteristics while maintaining superior performance

A comparative analysis of the lagging strategies to the equal-weight control group reveals that the rotation strategies consistently yield higher returnsMoreover, juxtaposing the lagging strategies against the foundational allocation of ultra-long bonds also indicates similar returns but with noticeably reduced volatility through the process, continuing to present advantagesFurthermore, the existing disparity between lagging and ideal strategies implies that if investors adapt to bond market transitions with heightened sensitivity, there remains significant room for optimizing rotation strategy returns.

03

Multi-Asset Allocation Approaches in the Current Climate

The prior segment explored strategies in single-asset rotations; however, practical implementation now allows for simultaneous allocations among varied asset classesRegardless of focusing on single or multi-asset configurations, the fundamental inquiry rests upon "how to identify superior assets during different phases". Translating this into a multi-asset context, the single-asset rotation strategies can indeed provide a framework conducive to asset weight allocations.

From a strategic viewpoint, a pragmatic multi-asset allocation framework may look as follows: initially, dilute allocations into 60% stable positions and 40% fluid onesFor stable allocations, convertible bonds, ultra-long rate bonds, and 3-5 year credit bonds would each carry equal proportions, maintaining a consistent stanceOn the other hand, flexible asset allocation would adjust according to prevailing conditions; specifically, during early February, the emphasis would lie on 3-5 year credit bonds, with a shift toward convertible bonds as mid-February approaches, culminating in heightened adaptivity as the National People’s Congress takes place in early March—adding heightened allocations to convertible bonds depending on policy outcomes.

The rationale underlying this structured approach stems from two observations

Firstly, the bond-type ETF rotation framework will assist in delineating which assets merit enhanced or restricted allocations.

Current market conditions reflect a phase characterized by "continued loose monetary policies with waning credit", evident in the financial figures from December 2024—where financing expansions reached a decade high of 2.86 trillion yuan, representing a year-on-year growth of 924.9 billion yuanWhile this superficially highlights emerging broad credit signs, corporate and household financing remains in decline, burdening overall social financing figures and indicating that the credit trend needs further consolidationThis implies that the present environment may not sufficiently empower excessive over-allocation toward convertible bonds; thereby, positioning them as strategic allocation necessities, perhaps allocating approximately 20% of total investments into them.

In terms of bond-like assets, the bond market may face three potential scenarios through February: first, the reissuance of government bonds with the central bank marginally easing its stance could ignite a simultaneous rebound across both short and long-term markets, with a potential for a parallel shift down the curveSecond, if the central bank continues with its emphasis on preventing asset-turned- liabilities while bank liquidity normalizes under M0 reversions, the incentivized suppression of short-term interest rates could manifest, constraining long-rate volatility within narrower bandsThird, persistent elevated costs in funding rates may uplift market risk appetites, thus igniting spring activities, reflected in an uptick in long-duration local bondsIn synthesis, the probabilities are weighted higher regarding long rates remaining steady or descending—aligning with insights from the bond ETF rotation framework signaling allocation values for both super-long and 3-5 year credit products.

Lastly, when managing flexible allocations, searching through rotation mentality alongside evolved strategies, presents insights into potential leading assets for various timeframes

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