Japanese banks eager to feast on more foreign bonds

Institutional investors in Japan are likely to maintain a foreign asset buying spree into US bonds into the autumn as they seek to use favourable market conditions to secure higher returns than what is available in the local bond market, say fund managers.

Japanese banks have been leading a push to build overseas debt positions, purchasing ¥13.4 trillion ($122.2 billion) of foreign securities over the 13 weeks since the beginning of May, according to a new report by Bank of America Merrill Lynch (BAML).

The banks are keen to build foreign debt positions before further interest rate hikes take place in the US and broader political volatility subsides. Masato Mishina, head of institutional sales at Nikko Asset Management, says the investors are likely to keep doing so for the coming few months at least.

"Yield, liquidity, and stability all make those markets attractive as destinations for investment, and they are popular," he said. 

US interest rates are likely to continue rising, so Japanese investors are more interested in floating rate bonds such as mortgage-backed securities and highly rated credit products that offer better yields than Treasuries, like municipal bonds, he added.

Noriaki Kurose, head of institutional sales at Pictet Asset Management Japan, told AsianInvestor he believes Japanese institutional investors would probably wait to issue new mandates to invest into US bonds until further interest rate hikes take place in the US.

He added that investors would likely be "opportunistic" when it came to investing more into European bonds space because rate hikes are not expected soon there—although the European Central Bank is tapering its quantitative easing policy. 

Asset buildup

US bonds are attracting Japanese investors—and especially banks—because they can net superior returns to local debt, even after the proceeds are swapped back into Japanese yen.

The US treasury yield curve is flattening while the cost of swapping US dollars to yen has been rising, and currently sits at about 1.6%. As a result, if investors buy US treasuries with a 2.5% yield, their total yen-denominated return would be 80 basis points, or 0.8%, said Mishina. That is still a lot better than 10-year Japanese Government Bonds, which currently yield 0.014%.  

“That’s why they want to buy US Treasuries before [the return spread] gets tighter and tighter. They have a high incentive to buy in this current market,” he said.

Japanese institutional investors' acquisition of foreign assets in the 13 weeks since May marked a seven-year high over such a period, according to BAML’s Japan Macro Watch report, released on August 23. 

Nearly 60% (¥7.8 trillion) of this total was into bonds, and Japanese banks were the most aggressive buyers, investing 70% (¥5.6 trillion) of that amount into foreign debt. They mostly bought US and European bonds, with French bonds in particular attracting Japanese investor buying. 

Multi-asset options

Japanese investor demand for overseas investing is likely to expand beyond single asset portfolios. Kurose said asset owners—particularly regional banks—are also becoming more intrigued by multi-asset strategies.

“Money is sitting in banks, provided some market uncertainty and geopolitical risks, they don’t know where to invest,” he told AsianInvestor. “Therefore, multi-asset type products are getting popular.”

But the potential for US interest rate hikes, tapering of QE in Europe, and geopolitical risk in North Korea has raised the appeal of an adaptable investing strategy like multi-asset, he argued.

He said some multi-asset products gaining interest are those that invest into equity index and bond futures.

Nikko Asset Management’s Mishina added that some are also weighing opportunities in Japanese equity, but noted that volatility is high and banks in particular do not want to expand holdings in them too much because of the Basel III accord. That said, some domestic investors have been seeking out high-dividend corporate equities as a way to diversify their portfolios.

Japanese asset owners are also weighing investments in equities and fixed income products in some of Asia’s higher-rated countries, mostly through regional funds in the region, he added.