Japan insurers' push abroad raises angst over yen, hedging costs

Tokyo

JAPAN'S insurers, prodded by the central bank to seek higher investments outside of government debt, are showing anxiety over rising hedging costs and currency risks.

Life and non-life insurers bought a net 6.98 trillion yen (S$79.5 billion) of local sovereign bonds in the 10 months to January, the lowest in seven years for that period and down 35 per cent from a year ago, Japan Securities Dealers Association data show. They bought a net 2.44 trillion yen in long-term foreign notes, after selling a net 290 billion yen a year earlier, government data show. A benchmark gauge of hedging costs was at its highest since October 2012.

The industry's 347.4 trillion yen in assets at the end of November were invested 42.9 per cent in Japanese government bonds and 18.6 per cent in foreign securities, boosting their exposure to swings in the yen, which has weakened 14 per cent in the past year against the dollar. Companies have to adopt flexible strategies, take hedging costs into consideration and examine overseas debt amid low domestic interest rates, said Dai-ichi Life Insurance president Koichiro Watanabe.

"Insurers' investment in a way is in line with Bank of Japan (BOJ) policy that's aimed at encouraging a shift from domestic to overseas bond investment," said Souichi Takeyama, a rates strategist at SMBC Nikko Securities Inc in Tokyo. "But insurers are also caught between a rock and a hard place as they are the ones who bear the risks."

BOJ governor Haruhiko Kuroda's efforts to encourage investments in riskier assets are starting to bear fruit as insurers seek higher returns to meet payouts coming due in one of the world's fastest-ageing societies.

Japanese bonds have lost 0.9 per cent this month, heading for their steepest decline since May 2013, Bloomberg World Bond Indexes show. The benchmark 10-year Japanese Government Bond (JGB) yield was 0.37 per cent on Tuesday after falling to a record low of 0.195 per cent last month. The 30-year rate was 1.42 per cent.

"Insurers aren't able to buy at a pace like before due to falling yields on super-long JGBs," said Takafumi Yamawaki, the chief rates strategist in Tokyo at JPMorgan Chase & Co. "Even if they boost foreign bonds, US and euro region yields are falling while dollar funding costs are rising. Bond investors globally are facing a harsh investment environment."

The threat of deflation globally is fuelling demand for fixed-income assets. Ten-year Treasury yields plunged to 1.64 per cent on Jan 30, the least since May 2013, while Germany's slid to a record low of 0.297 per cent on Feb 2.

The allure of currency-hedged foreign bond investments is declining amid expectations that the Federal Reserve will start raising interest rates later this year, said Masafumi Yamamoto, the president of Praevidentia Strategy, a financial research company in Tokyo.

London interbank offered rates for six-month dollar loans rose to their highest since October 2012 relative to those in yen at 24.7 basis points on Feb 20, suggesting that insurance companies' hedging costs are rising.

"As the longer-term outlook of the dollar-yen is for a higher dollar rather than a higher yen, life insurers could buy dollar bonds on the currency's dips without hedges and reduce the proportion of their current hedging ratio," Mr Yamamoto said.

Japan's currency weakened to a seven-year low of 121.85 per dollar in December . The yen will depreciate to 125 per dollar at the end of 2015, going by the median estimate of about 50 analysts surveyed by Bloomberg News.

The BOJ's stimulus programme, which involves buying as much as 12 trillion yen of domestic debt a month, has eroded insurers' JGB-dominated investment returns. Meiji Yasuda Life Insurance and Dai-ichi Life withdrew from some fixed-term insurance policies that pay higher interest rates than returns they achieve from their investments.

Takahiro Ootsuka, a market economist at Mitsubishi UFJ Morgan Stanley Securities Co in Tokyo, said that the central bank's policy is having its intended portfolio-rebalancing effect by pushing insurers to risk assets including foreign bonds.

The spread between 10-year Treasury notes and Japan's debt with similar maturity will widen to 2.2 percentage points by year-end from about 1.7 points on Tuesday in Tokyo, analyst estimates compiled by Bloomberg show.

"By default, they would have to boost foreign bonds investment but with US yields set to rise with a Fed rate hike, timing will be crucial for investment," Mr Ootsuka said. BLOOMBERG