Japanese Bonds Are Loved by Foreigners, Not So Much at Home

(Bloomberg) -- Global funds are trading a record share of Japanese bonds just as some of the nation’s largest investors are balking at adding to holdings.

The proportion of Japan bond and bill transactions made by foreign funds climbed to 37 trillion yen ($331 billion) in March, or 40.5 percent of the total, a record in data from the Japan Securities Dealers Association starting in 2004. The amount excludes trading by dealers, and is up from 38.2 percent in February.

Japanese Bonds Are Loved by Foreigners, Not So Much at Home

The divide between Japanese and foreign interest in the nation’s low-yielding, or even negative, debt comes partly because of the use of cross-currency basis swaps. By tapping the instruments, a dollar-funded investor can enjoy a yield pick-up of around 42 basis points by buying five-year Japanese government bonds over equivalent Treasuries.

In addition, a steeper relative yield curve to the U.S. and low volatility in the Japanese bond market boosting Sharpe ratios, a measure of risk-adjusted return, are encouraging foreign investors to buy yen bonds.

Logical Move

“It’s a logical move by foreign investors,” said Takenobu Nakashima, a senior rates strategist at Nomura Securities Co. “Falling carry from overseas curves is making Japanese bonds superior particularly in light of the very low volatility.”

Their presence though may be further depressing JGB yields, flattening the curve and making the bonds even less appealing to Japan’s life insurers, which traditionally have been some of the biggest holders of the securities.

“Current JGB yields are far from being attractive,” said Shinichi Okamoto, senior general manager in the finance & investment planning department at Nippon Life Insurance Co. “We are very cautiously investing,” given the low likelihood of an improvement in market conditions in the second half of the fiscal year, he said.

The Bank of Japan’s unprecedented easing has pinned its policy rate at minus 0.1 percent and it targets a 10-year bond yield around zero. The resulting hunt for yield from Japanese investors has sent a wave of yen abroad, driving up the premium dollar investors can earn buying yen assets via cross-currency basis swaps.

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