TOKYO -- Japanese life insurance companies are poised to step up investment in foreign government bonds without currency hedges, a move that may help serve as a bulwark against the yen strengthening past 110 per dollar.
Many life insurance providers hold foreign bonds with currency hedges that prevent their values from falling below par during adverse currency fluctuations. A common way to hedge is to sign yen future contracts or similar instruments that lock in exchange rates. That set of transactions has a neutral effect on the foreign exchange market, meaning the yen does not weaken as a result.
But an abundance of institutional portfolios adopting that approach jacks up the cost to hedge. U.S. short-term interest rates are climbing on speculation of another Federal Reserve rate hike, which in turn further raises fees for hedges.
During the first fiscal half ended September, the premium for dollar hedging hovered around 1.4 to 1.7 percentage points. Now the rate has jumped to 1.9 points. Meanwhile, yields for the 10-year U.S. Treasury bill, the benchmark for long-term U.S. interest rates, stand around 2.4%. Although the rate recovered from September, there has not been much of an upturn.
That puts the real rate of return of currency-hedged 10-year Treasury notes near 0.5%, a level falling short of super-long-term Japanese government bonds.
"At those returns, there's no point in investing in foreign bonds," said an asset manager at a major Japanese life insurance company.
Change of plans
Entering the second fiscal half to March 2018, life insurance groups have responded by either hedging corporate bonds or other vehicles that have higher yields than JGBs, or by simply opting for unhedged "open" foreign bonds.
In the second fiscal half, Nippon Life Insurance is cutting its balance of currency-hedged bonds and shifting to the open alternative. The first half saw the addition of 510 billion yen ($4.48 billion) worth of hedged foreign bonds, while further allocations of open foreign debt amounted to just 230 billion yen. For the second half, Nippon Life has decided to take on foreign exchange risk.
Also in the current fiscal half, Mitsui Life Insurance is projected to invest the equivalent of at least 100 billion yen more in open foreign bonds denominated in U.S. and Australian dollars. Sumitomo Life Insurance says it will consider investing in open foreign debt if the yen appreciates past the 110-per-dollar threshold.
Life insurers purchase open foreign bonds during periods when the yen gains strength. If the Japanese currency softens afterwards, those companies can profit off exchange margins.
"Yen selling by life insurance companies will act as a powerful brake against the strengthening of the yen," said Ryoko Tada at Nomura Securities.
Asset recovery
Long-dated U.S. Treasury yields spiked following Donald Trump's surprise election in November. Because yields move inversely to bond value, Japanese life insurers had shied away from that asset class. During the final six months of fiscal 2016, those companies bought 867.6 billion yen more in foreign bonds than they sold, down 6 trillion yen from the previous half.
Then in the first half of fiscal 2017, life insurers bought 1.77 trillion yen worth of foreign debt on a net basis, signaling a revival of that investment. The currency rate also moved in the 107 yen to 114 yen per dollar range during the same period.
"Life insurance companies purchasing open foreign bonds when the yen appreciated beyond 110 yen also had an effect," said a source at an international bank. Domestic life providers could loom bigger as a barrier against the strong yen this fiscal half.
