(Bloomberg) — Japanese investors are beginning to lose their decades-long obsession with foreign assets.
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In the first eight months of the year, Japanese investors snapped up a net ¥28 trillion ($192 billion) of the country’s government bonds, the largest amount in at least 14 years. They almost halved their purchases of foreign bonds to just ¥7.7 trillion, and their purchases of foreign equities were less than ¥1 trillion.
“This is going to be one of the mega trends and a super cycle for the next five to 10 years,” said Arif Hussain, head of fixed-income at T. Rowe Price, who has nearly three decades of investment experience. “There will be a steady, gradual but massive flow of capital back into Japan from overseas.”
With $4.4 trillion invested abroad, an amount larger than India’s economy, the speed and magnitude of any pullback has the power to disrupt global markets. Although the gap in rates between Japan and other countries has narrowed, the inflows have been a trickle rather than the flood some investors had feared.
Japanese overseas investment has been compared to a large carry trade, where investors took advantage of the lowest interest rates available at home to fund purchases abroad.
The extent of the flows depends on the speed and trajectory of rates in Japan. While Bank of Japan Governor Kazuo Ueda indicated that policymakers will be overly cautious on hike plans, strategists are almost unanimously predicting a stronger Japanese currency next year as views policy will inevitably normalize.
Yields on benchmark 30-year Japanese government bonds rose 40 basis points above 2% as the BOJ raised rates this year. It’s getting to the point where some of the country’s biggest insurers are looking to increase their holdings of local loans.
T&D Asset Management Co. A 30-year JGB yield of over 2.5% is said to be the level at which money is returned home. Dai-ichi Life Insurance Co. That said, yields above 2% on these bonds in April are relatively attractive. The yen weakened 0.4% to 144.16 against the dollar on Wednesday.
Japan Post Insurance Co. are still investing offshore, but “it has become easier to invest in yen-denominated assets,” said Masahide Komatsu, senior general manager of the firm’s global credit investment division. “We want to diversify our investments.”
The stakes are huge: Japanese investors are the largest foreign holders of US government bonds and hold about 10% of Australia’s debt. They control hundreds of billions of dollars worth of stocks from Singapore to the Netherlands and the US, owning anywhere between 1% and 2% of the markets. Their reach has expanded to high-risk investments, such as cryptocurrencies and the risky debt that blew up in Europe.
They built up holdings in years of sub-zero rates at home, and Alphabet Inc. from Brazilian bonds yielding more than 10%. Snapped up everything from shares and risky debt bundles in the US.
A prominent example of the move abroad is Norinchukin, Japan’s largest agricultural bank, which has invested a significant portion of its ¥60 trillion securities portfolio in US and European government debt. It is now in the process of unwinding ¥10 trillion in foreign holdings after an unexpected rise in rates pushed up its funding costs and plunged the bank into losses. San-in Godo Bank Ltd, a regional bank based in western Japan, also plans to significantly increase its holdings of JGBs while selling Treasuries.
A nightmarish scenario for markets could be a more extreme form of the Aug. 5 turmoil, when higher Japanese rates and a slowing US economy led global hedge funds and other foreign speculators to rapidly exit carry trade bets. The Nikkei 225 suffered its biggest loss since 1987, as Wall Street’s gauge of stock volatility rose and the yen advanced. Even gold, a haven, fell during times of stress.
Japanese investors – including the world’s largest pension funds and insurers – are largely dormant, underscoring the potential for further tectonic shifts.
The confusion prompted the BOJ to say it would consider market conditions before raising rates again and would hold off if markets were volatile. In addition, the Federal Reserve cut rates by half a percentage point in September in an effort to preserve the strength of the US economy.
“August gave us a glimpse of the repatriation trend,” said Charu Chanana, global markets strategist at Saxo Markets. “The Fed’s commitment to achieving a soft landing has reduced the odds of a recession. This means future repatriations may not be as abrupt.
While policy is normalizing, Japanese rates are hundreds of basis points lower than counterparts in the US and Europe, meaning offshore assets still appeal to yield-hungry investors who can tolerate currency risk. Japan’s Government Pension Investment Fund, one of the world’s largest pension funds, targets nearly half of its holdings in foreign bonds and equities. Those positions helped offset losses in domestic debt during its last reporting period.
Japanese investors “realize that U.S. markets are still incredibly liquid, very large, and offer a lot of diversification,” said Anders Persson, global head of fixed income at Nuveen LLC. “They’re looking for a little bit more yield-type opportunities.”
After market turmoil in August, JPMorgan Chase & Co. Carrie estimates that up to three-quarters of the trade has not declined. That analysis looked at global businesses funded by borrowing in currencies at low rates. With the BOJ benchmark rate at 0.25%, the yen still fits those criteria. When that changes, the incentives for the Japanese to bring their money home will increase.
“Investors everywhere are underestimating the risk of large repatriation flows over the long term,” said Shoki Omori, chief desk strategist at Mizuho Securities Co. in Tokyo. “The Japanese are big carry traders. The trend is already continuing — watch this space.
–With assistance from Aai Tomisawa, Matthew Burgess, and Daisuke Sakai.
(Updates with yen in paragraph 8)
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