It is estimated (HSBC Research) that 12.6% of Japanese investor’s $44b US overseas bond purchases in 2014 made it into Australian Dollar bonds. That is over $5b US. With recent changes as to how Japanese Pension funds invest, it is estimated a further $63b US of investment will be made in Australian bonds in the next two to three years.

Bonds and other assets are an attractive option for investors in this low interest rate environment. However as their performance is strongly supported by interest from overseas investors, local investors must watch for changes in central bank policies, as Quantitative Easing policies may cause money to exit the market, triggering a sell-off.

Introducing Mrs Wantanabe

Mrs Watanabe is illustrative of the typical Japanese housewife, someone who protects the family’s savings and looks after the budget. She broadly represents Japanese retail investors who are historically risk-adverse, yet invest in bonds that take big currency bets. Since the era of the “lost decades” (1991-2007 where growth went backwards and asset prices remained stagnant), Mrs Watanabe has continued to save, and been investing in Urisdashi bonds.

Uridashi bonds

In Australia bonds are primarily offered to Sophisticated (or Wholesale) Investors. Sophisticated investors are prequalified, having met certain monetary tests, and holding a valid investor certificate.

However in Japan, Uradashi bonds are offered to retail investors, meeting no such tests. The investor exchanges their Yen to invest in a bond in a foreign currency, which pays the foreign country’s interest rate to the investor, and the initial investment upon maturity. Australian dollar denominated bonds have long been a favourite; given our relatively high interest rates, positive economic growth, and currency.

The investor effectively sells/borrows Yen (which is a low cost currency) and buys/invests in high growth currencies – this is also known as “the carry trade”.

For Mrs Watanabe, this means she can walk into her bank branch and convert her Yen into Australian Dollars, purchase a Uridashi bond (which may be issued by Westpac Bank, Toyota Finance Australia or others), receive the relevant Australian interest rate for the term of the bond, and be paid her bond’s face value in Australian Dollars on maturity.

Credit risk, currency risk, interest rate risk… Not that conservative after all, and all for a retail investor?

Mrs Wantanabe learns Abenomics

With Japan flirting with recession over the last 2 decades, the current Prime Minister (Shinzō Abe) introduced “Abenomics” to Japan. This involved monetary and fiscal policies to stimulate economic growth. In April 2013, Abe pushed Japanese debt higher, in an all out effort to lift the ailing economy. He introduced money printing (quantitative easing). The Yen depreciated, and the Japanese stock market rallied. Mrs Watanabe was happy to let her Uridashi mature, convert back to a weaker yen, and keep some of her money at home.

More recently, Australia’s currency has fallen, and interest rates are around 1930’s depression lows. The Australian 10 year bond yields around 2.5%, and the equivalent Japanese bond is around 0.40%.

Abe’s policies have an aging Mrs Watanabe looking for higher returns. She’ll be a part of this ongoing QE-fuelled investment wave. However, she is also looking beyond “conservative” investments such as bonds, and is now considering shares, hybrids, property trusts and infrastructure funds. Mrs Watanabe has been almost the polar opposite of the Australian investor, but is finally discovering there is more to life than a Uridashi bond.