U.S. Junk Bonds + Brazil Currency Bets = Big Headaches in Japan

  • High-yield funds tied to real lost as much as 31% this year
  • Brazilian currency dropped by a third against yen in 2015

If investors are bracing for their first annual loss on U.S. high-yield bonds since 2008, spare a thought for Japanese moms and pops who put their money into funds that bought the debt and mixed it with bets on emerging currencies. It’s proving to be a toxic cocktail.

High-yield funds tied to the Brazilian real and sold to investors in Japan have lost 28 percent to 31 percent this year. That made them the 10 worst-performing Japanese mutual funds that buy speculative-grade debt, with a combined 237 billion yen ($1.97 billion) of assets as of Dec. 22. There are more than 1 trillion yen of high-yield mutual bond funds in Japan tied to currency wagers, which seek to lift returns by boosting risk, according to calculations by Bloomberg.

Losses on so-called double-decker or layered funds highlight the dangers Japanese investors face as they venture into riskier investments in search of higher returns with the Bank of Japan pushing ahead with asset purchases. Japan’s pension funds and life insurers are also buying more overseas debt as they seek to meet payouts to the fastest aging population in the developed world with local sovereign bonds to three years paying negative yields.

“People look in the paper and see advertisements with yields of 10 percent and 11 percent, and think it’s a good idea to buy because they don’t get any yield in Japan,” said Edwin Merner, the president of Atlantis Investment Research Corp. in Tokyo. “We can laugh but if somebody put money in, they are crying.”

Double-Decker Funds

Slumping oil prices this year weighed on energy debt, putting the U.S. junk-bond market on track to post an annual loss for the first time since 2008, and triggering redemptions. Funds run by Third Avenue Management and Stone Lion Capital Partners have halted cash repayments as investor demand drained their liquid assets. Lucidus Capital Partners liquidated its entire portfolio and plans to return $900 million to clients next month.

Japan’s biggest brokerages and banks, including Nomura Holdings Inc. and Mitsubishi UFJ Financial Group Inc., sell double-decker funds to customers.

Tetsu Yoshimura, a spokesman for Nomura in Tokyo, declined to comment on individual investment products, as did a spokesman at Mitsubishi UFJ.

Dividend Demand

The worst-performing high-yield mutual bond fund in Japan this year is managed by Mitsubishi UFJ Kokusai Asset Management Co., a unit of Japan’s biggest bank. It’s lost 31 percent through Dec. 22 and like many Japanese mutual funds pays holders a monthly dividend. The fund paid out 60 yen for every 10,000 yen invested in each of the last eleven months to November, according to the asset manager’s website.

“Funds that pay out monthly dividends in Japan are very popular amid low interest rates,” said Hiroaki Sakamoto, an analyst at fund research company Morningstar Japan K.K. in Tokyo. Double-decker bond funds that offer monthly dividends are particularly in demand among the elderly, he said.

The Mitsubishi UFJ Kokusai Asset fund is invested in U.S. speculative-grade debt and linked to the Brazilian real. Ties between Japan and Brazil have grown for more than one hundred years, with emigration from the Asian nation to the South American country beginning at the start of the last century. There are about 1.6 million people of Japanese descent living in Brazil and about 180,000 Brazilians in Japan, according to Japan’s Ministry of Foreign Affairs.

Brazil’s currency has dropped 32 percent against the yen this year. The nation’s president Dilma Rousseff revamped her economic team earlier this month with the appointment of Nelson Barbosa to the post of finance minister as Latin America’s largest economy is in the middle of its longest recession since the 1930s.

Currency Selection

Japanese financial institutions also offer individuals funds that invest in everything from domestic stocks to U.S. real estate combined with a currency option for different countries. Given the poor performance of the Brazilian real this year, such investors are looking to buy more U.S. dollar-denominated funds, said Morningstar’s Sakamoto.

Japan’s 135.1 trillion yen Government Pension Investment Fund lost 5.6 percent, or 7.9 trillion yen, in the three-months through September, its worst quarter since at least 2008, as it shifted funds out of local government bonds into more equities and overseas debt. The fund lost 8 trillion yen on its domestic and foreign equities and 241 billion yen on overseas debt, while Japanese bonds handed GPIF a 302 billion yen gain.

Hiroyuki Mitsuishi, a GPIF councilor, said last month its performance should be viewed over the long-term. The fund will invest in global high-yield bonds and they are important for GPIF’s asset diversification, he said.

Non-Yen Caution

Nomura’s U.S. high-yield fund tied to the Brazilian real has lost 29 percent this year but still has an average annual return of 1.8 percent over the past five, according to data compiled by Bloomberg. Those figures don’t include a purchase fee equivalent of up to 3.24 percent of the acquired amount, trading expenses for the fund and a separate annual management fee of more than 1.5 percent.

When buying non-yen investments, Japanese individuals should stick to buying lower-fee products such as tracker funds sold by local asset managers, according to Martin Malone, a global macro policy strategist at London-based brokerage Mint Partners Ltd.

“It’s appropriate for any retail investor to have 20 percent to 30 percent of long-term investment in ‘external’ investments or non-yen products,” said Malone. “But the only ones should be what GPIF and other institutional investors buy.”

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