GPIF Pivots to Yen Hedging Just as Other Investors Cut Back

(Bloomberg) -- Japan’s Government Pension Investment Fund is adding currency hedges just as the country’s most well-known exponents of the strategy cut back.

The world’s largest pension fund, which oversees the equivalent of $1.46 trillion, revealed in its annual report last month it was buying overseas bonds with hedges against possible yen fluctuations for the first time. Earnings reports from Japanese life insurers show they cut the proportion of the portfolio they hedge to 55% in March, from as high as 63% in September 2016.

Whether or not to hedge is a tricky equation for many Japanese firms that hold overseas assets. While adopting protection can safeguard their foreign-currency denominated assets from losing value if the yen strengthens, purchasing hedges comes with a price. The cost of hedging for dollar assets has become particularly expensive due to interest-rate differentials and rising demand for the U.S. currency.

“It’s hard to imagine Japanese investors being in a rush to boost yen hedging,” said Yukio Ishizuki, senior currency strategist at Daiwa Securities Co. in Tokyo. “The investment environment is really dire, and hedging inevitably erodes returns.”

GPIF’s latest annual report showed it held a total 588.2 billion yen ($5.4 billion) of assets tracking an FTSE Russell Index of U.S. government bonds that incorporates currency hedging, along with 668.6 billion yen of hedged European sovereign debt. While that equates to only about 4.6% of its total overseas bond portfolio, this is the first time the fund is buying bonds with hedges in place, according to its annual reports. The fund will release its quarterly performance results on Friday.

Nine of the largest life insurers held a combined 31.5 trillion yen of bullish wagers on Japan’s currency using forwards as of March 31, compared with a total 57.2 trillion yen of overseas assets. Their hedging proportion for dollar assets is 47% and for euro ones is 78%, a Bloomberg analysis of their reports shows.

Hedging euro-denominated assets by yen-based investors pays a premium of 0.22%, meaning it contributes to the total profit that can be earned. In contrast, hedging of dollar assets costs an annualized rate of about 2.6%, which means even holders of U.S. 30-year Treasuries would not earn enough yield to cover the expense.

The Bank of Japan at a policy meeting Tuesday reaffirmed its commitment to keeping interest rates low. Given yields are negative for all Japanese government bonds up to 10 years left to maturity, the country’s investors are set to keep sending money abroad in search of higher returns, which means whether or not to hedge will remain a key question.

Will the GPIF’s change in hedging strategies have any impact on the yen? Analysts say that’s unlikely as it will be countered by rising flows into overseas assets.

The GPIF’s decision to buy currency hedges with its investments isn’t a yen bullish factor, Tohru Sasaki, head of Japan markets research at JPMorgan Chase & Co. in Tokyo, wrote in a note on Monday. “The amount of Japanese overseas investment flows have been increasing in the past few years and they are one of major reasons why the yen remains at the historical weak level in real terms.”

--With assistance from Shigeki Nozawa.

To contact the reporters on this story: Masaki Kondo in Tokyo at mkondo3@bloomberg.net;Chikako Mogi in Tokyo at cmogi@bloomberg.net

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

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