Japan’s Most Cautious Investors Are Taking More Dollar Risks

(Bloomberg) -- As the decade that welcomed unprecedented quantitative easing comes to a close one thing is clear: Japan life insurers are taking more and more risk with their investments.

A combination of ever lower bond yields and elevated costs have seen Japanese life insurers cut their hedges on dollar investments to the lowest in at least 10 years, according to calculations by Bloomberg. Despite holding $354 billion in dollar-denominated assets, nine of the biggest insurers had hedged just $164 billion of them against a decline in the greenback, the data as of the end of September showed.

The steady reduction of protective bets against adverse dollar moves comes as elevated hedging costs turned Treasuries into negative-yielding debt for Japanese investors. While the carry-trade like strategy adopted by life insurers will boost returns, a sudden surge in the yen will leave them with big capital losses.

The reduction in hedging suggests “life insurers expect any strength in the yen to be limited,” said Shinichiro Kadota, a senior foreign-exchange and yen-rates strategist at Barclays Plc in Tokyo. “Given caution has receded toward a stronger yen, a sharp gain could see an undue impact” on hedging activity, he said.

Four life insurance companies, including the biggest players Nippon Life Insurance Co. and Japan Post Insurance Co., said in October that they plan to increase holdings of unhedged foreign debt in the second half of the fiscal year ending in March.

Mild Appreciation

The yen is on track for its fourth straight year of modest gains against the greenback and has been trading in the smallest range on record this year. A combination of factors such as the unhedged outflows and the steady growth in Japanese acquisitions abroad have all helped keep a lid on yen strength.

Strategists are expecting a mild appreciation of just 3% to the 105 level by the end of 2020, according to data compiled by Bloomberg.

Meanwhile, buying protection against a stronger yen for six months costs Japanese investors 2.14% on an annualized basis, according to Bloomberg data. That compares with the 1.76% yield available from benchmark 10-year Treasuries, and the 2.21% an investor would get from its 30-year equivalent.

“There is little demand for Treasuries from Japanese investors because hedging eats up their yields,” said Hiroshi Yokotani, managing director and portfolio strategist for fixed income and currencies at State Street Global Advisors.

The QE Effect

Almost seven years of unprecedented Bank of Japan stimulus has driven much of the domestic yield curve into negative territory, sending the country’s investors abroad in search of returns and adopting riskier strategies such as unhedged positions. The top life insurers are now turning to equities and corporate bonds to safeguard returns, according to recent strategy presentations.

The nine insurers studied are hedging 46.3% of their dollar-denominated assets as of September, down from 73.2% a decade ago, according to a Bloomberg analysis. As an industry, they own 100 trillion yen ($919 billion) in foreign securities

With hedging euro positions actually returning a premium for yen investors, European securities have proven popular in the Asian nation. After adjusting for exchange-rate fluctuations, life insurers’ holdings of euro assets increased 14% during the six months ended Sept. 30, compared with a gain of 8.6% in dollar-denominated securities.

“Hedge costs are still too high,” said Minori Uchida, Tokyo-based head of global market research at MUFG Bank Ltd. “Because the yen’s volatility remains low, investors are taking a wait-and-see stance for hedging.”

The yen has appreciated against all its major peers so far this fiscal year, underscoring the risk of unprotected overseas investment. Life insurers held a higher hedge ratio for the Australian dollar at 62.7%, compared with 43.7% for the Canadian dollar.

--With assistance from Chikafumi Hodo.

To contact the reporters on this story: Masaki Kondo in Tokyo at mkondo3@bloomberg.net;Daisuke Sakai in Tokyo at dsakai2@bloomberg.net

To contact the editors responsible for this story: Tan Hwee Ann at hatan@bloomberg.net, Cormac Mullen

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