Marcus Ashworth is a Bloomberg Gadfly columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

Japanese life insurers have a problem. Rates at home are stuck near zero, and yields are rising abroad.

Thin Pickings
For Japanese investors to get any form of return in government bonds, they're forced out to the very longest maturities
Source: Bloomberg

They have an answer. This week, the major firms laid out their investment plans for the next six months -- and they all want to increase holdings of longer-term overseas bonds. Their foreign assets topped 1,000 trillion yen ($8.8 trillion) for the first time recently, according to Ministry of Finance data, a 50 percent rise over the last five years.

Yield Hunt
Japan's major life insurers are diversifying their portfolios to higher-yielding foreign bonds
Source: Bloomberg

For the first half of the Japanese financial year, which starts in April, life insurers hedged most of their their foreign bond purchases, in order to guard against risks from currency moves. As short-term yields overseas rise, so does the cost of hedging back into yen. This can make holding foreign bonds unhedged more attractive.

But that carries risks. Fortunately, given the relative position of foreign exchange markets and life insurers' increased risk appetite, Japanese buyers are now willing to consider forgoing the normal protections. The beneficiary here should be the U.S.

The cost of buying Treasuries on a currency-hedged basis is at the most expensive since the 2008 financial crisis. U.S. short-term money-market rates are rising on expectations of further Federal Reserve policy tightening, whereas yen rates are below zero. This has widened the differential between short-term yen fixed-income yields to dollar debt yields to nearly 200 basis points.

Hedging Dilemma
The cost for Japanese investors to offset foreign exchange risk for U.S. assets has risen as the Fed tightens policy
Source: Bloomberg News
Produced with the assistance of Bloomberg's Masaki Kondo in Singapore

The problem is that, on a hedged basis, the pickup for a 10-year U.S. bond is only 50 basis points. On an unhedged basis Japanese investors can get the same yield as everyone else: 2.45 percent. This is why they're increasingly looking to make U.S. bond purchases outright and just take their chances of the yen strengthening.

The risk, foreign exchange and otherwise, of putting all their money into the U.S. unhedged is too great. Europe beckons. Here, there's one clear winner.

Japanese life insurers prize liquidity, so in Europe they're less interested in the smaller core markets of Austria, the Netherlands, Finland or Belgium. While they do have some holdings of peripheral countries such as Italy or Spain, they tend to view these more as "credit" holdings, and rarely go longer than three years in maturity.

So, they tend to buy French and German securities, which they regard as the most liquid and safe. They view French government bonds, also referred to as OATs,  as "bunds-plus."

French Connection
For the Japanese investor returns are rising for currency-hedged French bonds
Source: Bloomberg
Return calculation: (French 10-year bond yield - three-month Euribor + three-month yen Libor +(Yen basis swap - Euro basis swap))/100

This caused them some grief in the run-up to the French presidential elections. But now that Emmanuel Macron is president, the European waters are calmer. Don't be deceived by the drop-off in purchases lately -- that was just profit-taking for accounting purposes as the end of the first half of their fiscal year approached. 

European Dream
Japanese life insurers banked some profits from their foreign bond purchases toward the end of their fiscal first half. Buying should resume.
Source: Japan Ministry of Finance, Bloomberg,

The best way for insurers to realize their plans in Europe is to focus on France -- on a hedged basis. Ten-year OATs, hedged back to yen, offer a 20 basis point pick-up to 30-year JGB yields. That is a return of 106 basis points, beating the 65 basis points for 10-year bunds. And if you were wondering what the returns are unhedged -- it's 80 basis points for France and 40 basis points for Germany.

Europe's fixed-income market has other friends besides Mario Draghi. Japanese life insurers heading into their second half will play their part.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Marcus Ashworth in London at

To contact the editor responsible for this story:
Jennifer Ryan at