Even at 0.3% Japan's Funds Are Loving 20 Years of Risk in Bonds

  • MUFJ Kokusai plans to hold on to shortest debt with any yield
  • `We're handling client money' so must find returns, fund says

Japan’s second-biggest bond fund says it will favor securities with whatever maturity it takes to get any positive yield. That means 20-year debt.

Mitsubishi UFJ Kokusai Asset Management Co.’s Global Sovereign Open Fund has been increasing its holdings in the maturity, said Tatsuya Higuchi, chief fund manager in the fixed income investment division. Debt maturing in 20 years or more returned 19 percent this year, compared with 1.3 percent for shorter-dated securities, data compiled by Bloomberg show. Yields on sovereign bonds maturing in as long as a decade have fallen below zero since the central bank announced a negative interest rate policy in January.

“If you add liquidity to the equation, the 20-year bond offers the best balance of risk and return,” Higuchi, whose flagship fund manages about 789 billion yen ($7 billion), said in an interview in Tokyo. “Given that we’re handling client money, it’s hard to justify investing in products with negative yields -- but bonds with slightly longer maturities still offer positive yields.”

Debt yields have collapsed since the Bank of Japan decided to charge financial institutions for some deposits, forcing investors to buy and hold ever-longer maturities. The amount of Japanese government bonds with negative yields has swollen to more than $5 trillion, a BOJ operation to buy long-term notes last week met the lowest investor participation on record, and the yield on 40-year bonds plunged 20 basis points on Tuesday in thin trade to below that of 30-year securities.

‘Profit Opportunity’

The 20-year bond yielded 0.37 percent as of 10:20 a.m. in Tokyo on Wednesday, after dipping to 0.29 percent on March 18 for the first time ever. The yield on the 10-year security reached a record minus 0.135 percent on the same day, and was recently minus 0.08 percent.

Higuchi points to a steepening in Japan’s sovereign yield curve between the 10- and 20-year bonds to suggest there is still a “profit opportunity” in the longer-dated security -- even after the spread narrowed as much as 40 basis points in the month to March 9.

Higuchi’s confidence in buying longer-term debt stems from the belief there won’t be a quick recovery in Japan’s economy, amid subdued growth and inflation in developed markets globally since the 2008 financial crisis. The average duration of JGB holdings is 16.5 years, the longest in the fund, which Morningstar Inc. ranks as the second biggest by assets in Japan among global bond funds. By contrast, the average duration of Treasury notes in its portfolio is 5.9 years, according to the firm.

Yen Weakness

Higuchi also predicts the BOJ and government will need to press on with stimulus, with inflation stuck near zero for more than a year and the economy shrinking in five quarters since Shinzo Abe became prime minister. That should eventually lead the yen to resume weakening against the dollar, Higuchi says, after Japan’s currency surprised analysts and investors by outperforming all its developed-market peers this year.

“If the trend for a weaker yen stops, there are many ways in which it will be a negative for corporate profits, cutting the speed of the recovery,” he said. “In order to support the economy, the central bank needs the yen to continue on a gradual weakening path.”

World Beater

On the other side of the equation, Higuchi sees the U.S. economy keeping its position as a world beater, lifting its currency along with Treasury yields. There too, he prefers longer-term debt over short-term securities, which he says are too exposed to shifts in the outlook for monetary policy. The probability in futures markets of another Federal Reserve rate hike in 2016 has swung from 93 percent at the start of the year to as low as 11 percent in February, before rebounding to 76 percent.

It’s the outlook for the currencies and the U.S.’s higher yields that have prompted Higuchi to keep Treasuries as his main investment at about 40 percent of the total, even as he built up his position in JGBs to about 12 percent over the past year, the second-highest proportion in the portfolio.

“In a world where the number of bonds with negative yields continues to rise, the U.S. Treasury market -- where positive yields are the norm -- is still very attractive,” he said.

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