Norway Buys Yen Bonds as Local Pension Fund Cuts: Japan Credit

Aug 24, 2014 11:23 pm ET

Aug. 25 (Bloomberg) -- Norway’s wealth fund, the world’s biggest, is diving into Japanese sovereign bonds, even as Japan’s government retirement fund prepares to cut holdings.

The Oslo-based Government Pension Fund Global increased Japanese sovereign allocations 15 percent to 160.8 billion kroner ($26 billion) in June from the end of 2013, its biggest debt holding after U.S. Treasuries, the investor said. Japan’s Government Pension Investment Fund, the world’s largest pool of retirement money, has signaled it will put more of its $1.23 trillion into domestic and overseas equities.

While Japan’s benchmark 10-year yields are the lowest globally after Switzerland’s, the notes offer a premium of 80 basis points more than equivalent U.S. debt swapped into dollars using derivatives called basis swaps, Bloomberg-compiled data show. Even as GPIF considers trimming, overseas investors are moving into Japanese government bonds on concern markets elsewhere will suffer losses from rising interest rates.

“JGB returns don’t look too bad when we take basis swaps into consideration,” said Kazuto Doi, a Tokyo-based portfolio manager at Western Asset Management Co., whose company oversees $468.9 billion. “JGBs are stable even as there are risks of yields rising overseas so they are easy for investors to hold from a risk-return perspective.”

JGB Return

Japan’s bonds made up 7.8 percent of the Norway fund’s fixed-income holdings as of June 30 and they returned 1.7 percent in the second quarter, the investor said in its quarterly report released last week. U.S. Treasuries, comprising 20.5 percent, earned 1.3 percent. The biggest increases in bond holdings for the $880 billion fund were in Japanese, U.K. and German debt.

Norway’s JGB boost is in line with increased demand from overseas investors for the debt of the world’s third-largest economy. Foreigners bought a net 1.27 trillion yen ($12.2 billion) of JGBs in July, the most since June 2012, according to Japan Securities Dealers Association data. Overseas investors also purchased 16 trillion yen of treasury-discount bills.

Japan’s bill yields on July 10 dropped below zero in what’s known as when-issued trading, which takes place as investors trade a security before it is sold at auction.

“Foreign buying of JGBs was unexpected,” said Makoto Suzuki, a senior bond strategist in Tokyo at Okasan Securities Co. “The biggest factor has been safe-haven demand amid geopolitical risks. There are also deep-rooted expectations that the Bank of Japan will ease monetary policy further.”

Allocation Shift

All 10 fund managers, strategists and economists in a Bloomberg News survey expect the 128.6 trillion yen GPIF to trim its holdings of domestic debt, with six projecting a cut to 40 percent from 55 percent at the end of March. The fund will boost its Japanese stocks target to 20 percent from 16 percent, according to the median estimate.

Shinichirou Mori, the director in charge of communications at GPIF in Tokyo, declined to comment on asset allocations, saying that a committee is in the midst of reviewing ratios. Yngve Slyngstad, the chief executive officer of Norges Bank Investment Management, which oversees Norway’s wealth fund, declined to comment on its investments in Japan.

In the U.S., the U.K., Germany and France, yields on short- term debt, which is among the securities most sensitive to changes in monetary policy, are rising faster than those on longer maturities.

Policy Outlook

Futures traders saw a 54 percent chance on Aug. 22 that the U.S. Federal Reserve will raise its benchmark interest rate to at least 0.5 percent by July.

In contrast, half of the 34 economists surveyed by Bloomberg expect the BOJ to bolster stimulus by the end of February 2015, according to a survey conducted from July 30 to Aug. 1. The central bank is now trying to accelerate inflation to 2 percent by buying about 7 trillion yen of JGBs a month.

Japan’s steepening yield curve may be one of the factors attracting foreigners, according to Western’s Doi.

“The increase in foreign buying of Japan’s super-long bonds is pretty logical when we look at the yield curve,” he said. “Japan has relatively wider yield spreads as the BOJ continues to ease policy.”

The yield premium Japan’s 30-year government bonds offer over 10-year debt was 114 basis points on Aug. 22, near a 17- month high of 117 basis points reached last month. That is the second widest among the Group of Seven nations after Italy and compared with 75 basis points for the U.S. A basis point is 0.01 percentage point.

Overseas Investors

“When foreigners look at investing in Japanese bonds using instruments such as basis swaps, the super-long end looks relatively cheap on the curve,” said Toru Suehiro, a market economist at Mizuho Securities Co. “The Norwegian pension fund is considered one of the most active investors among its global peers. As European yields fall, Japanese bonds, especially those on the super-long end, may look attractive to them.”

The three-month rate to swap dollars for yen rose 1.75 basis points to minus 12.75 basis points in July, the biggest gain this year. The rate was at minus 15.63 basis points today.

The yen traded at 104.18 per dollar as of 10:27 a.m. in Tokyo. It strengthened 3.8 percent in the first half of the year as investors sought safety from turmoil in Ukraine and Gaza. The currency plunged 18 percent in 2013, the biggest annual drop in more than three decades, after the BOJ unveiled its unprecedented stimulus program on April 4 of that year.

“Foreigners have a bigger presence in short-term debt,” said Yusuke Ikawa, a rates strategist in Tokyo at UBS AG. “But I wouldn’t be surprised to see some of the capital seep into notes maturing in more than a year as the bill market is looking increasingly overheated.”