Unhedged foreign bonds, an uptick in equities and further steps in alternative assets.

Those were the highlights of the investment plans of Japan's biggest life insurance companies for the six months to March 2020, the second half of Japan’s financial year. The tweaks come amid the challenge of a low interest rate environment globally which makes traditional bond investments increasingly unprofitable.

The trends are a sign that the lifers plan to stick to minor, conservative tweaks of their investment strategy to accommodate the current economic landscape, according to Teruki Morinaga, director of insurance at Fitch Ratings Japan.

The changes, therefore, have no notable ratings impact at the moment, he said, after he had gone through the asset allocation plans of nine Japanese major traditional life insurers.

“My understanding is that overall foreign bond investments are likely to increase further in order to seek higher yield. Based on their current plans, they will moderately increase unhedged bonds and moderately decrease hedged bonds,” Morinaga told AsianInvestor.

Soichiro Makimoto

At another ratings agency, a similar assessment was reached by Soichiro Makimoto, vice president and senior analyst at Moody’s Investors Service.

“Overall, we expect Japanese insurers will only gradually increase their risk exposure given their sound investment risk management. In particular, we expect currency and credit risk to rise for the insurers as they shift to riskier investments in pursuit of higher yields,” Makimoto said.

Strong earnings from underwriting are helping Japanese life insurers to cope with low-yields, but the pressure to continue to diversify is building.

GOING UNHEDGED

“Whether each insurer prefers hedged or unhedged would depend on the level of FX market volatility and the level of hedging cost of the Japanese yen versus the US dollar, which partly depends on US short term interest rates,” Morinaga said. 

Sumitomo Life is one of the insurers that plans to increase the holdings of foreign bonds without currency hedging in the current half-year to March 2020. Toshio Fujimura, head of Sumitomo’s investment planning department, told reporters at a news conference that he could not quantify the expected amount at this point time.

“Our aim here is to earn income gains, not to bet on currency moves,” he told reporters. In contrast, Sumitomo has no plans to increase the size of currency-hedged foreign bond investments in the current half-year, he added.

Currency hedged foreign bond investments have been popular among Japanese investors for years. But rising costs of dollar hedging thanks to higher US interest rates are now making that strategy increasingly unattractive.

The insurer’s growing risk exposure to unhedged foreign bonds is manageable because the growth has been gradual, according to Makimoto. Furthermore, insurers have strengthened their capital buffer against the incremental risk exposure, with stable and strong underwriting margins supporting growth in accumulated earnings and hybrid bond issuance.

“Unhedged foreign bonds were partly purchased to match the foreign-currency liabilities of foreign-currency insurance products so that there is no mismatch for the bonds,” Makimoto added.

If Japanese lifers expect the foreign exchange market to be stable and the cost of hedging to become even higher, then they may prefer unhedged bonds, and vice versa, Morinaga said.

Whether hedged or unhedged would be determined flexibly by each insurer, because the foreign exchange market between the US dollar and the Japanese yen is relatively liquid. Both currencies are among the most popularly traded and owned hard currencies in the world, he added.

FINDING ALTERNATIVES

The Japanese life insurers, however, are not only compensating lack of returns from hedged bonds by moving into unhedged territory. Diversification and returns are sought in equities and alternative assets as well.

“Most Japanese traditional lifers plan to increase domestic and foreign equity investments moderately. However, given the high-risk charge by regulators and rating agencies, I expect Japanese lifers will be able to increase allocation to equities only marginally,” Morinaga said.

As for alternative investments, Morinaga believes the trend is likely to be contained to major players – such as Nippon and Dai-ichi – that will continue to accumulate alternative equity investments including private equity debt.

Dai-ichi has confirmed plans to continue to add alternative assets over the six months through March 2020. These will include hedge funds, private equities and real estates, Akifumi Kai, general manager of investment planning, told reporters at a news conference.

Even these relatively larger life insurer’s alternatives venture will be to a far lesser degree than Japanese corporate pension funds which are much more assertive about the asset class.

“The allocation to these alternative assets will continue to be very small compared to their sizeable total investment portfolios. Smaller lifers also started to marginally invest in alternative assets, but the amount seems to very small at this stage,” Morinaga said.