Japanese life insurers flock back to JGBs for their relatively higher yield
Japanese life insurers plan to buy more domestic fixed income, with a focus on the 30-year — so-called super-long — Japanese government bonds (JGBs).
Nippon Life, Japan Post Insurance, and Sumitomo Life are among insurers that have detailed their investment plans for the rest of the fiscal year (ending April) at briefings last month, specifically addressing their super-long JGB stance.
"There is now an attractiveness to Japanese government bonds, [while] the attractiveness of hedged foreign bonds is waning," a Japan Post Insurance representative said in a briefing on October 21. "We have already been shifting from hedged foreign bonds into JGBs, and we will continue to do so."
The hedged foreign bonds are losing favour as hedging costs have soared following the depreciation of the yen this year. On November 15, 2021, one US dollar cost ¥114.12. A year later, the same US dollar cost ¥140.43, an increase of 23%.
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A BETTER MATCH
The super-long JGBs were trading at the highest levels since 2014, when they saw a peak of 1.632% on October 25. As recently as the beginning of the year, its yield was only 0.699%.
"Anything above 1.5% and we can consider additional investment [in the 30-year JGBs],” said a representative from Sumitomo Life at a briefing on October 25.
Because of the low yields in recent years, Japanese life insurers have only recently pivoted back into investing heavily into super-long JGBs. It is a preferred investment, given that Japanese insurers’ asset durations are generally shorter than those of liabilities — lengthening asset duration by increasing long-dated JGBs will reduce interest rate risk.
“For life insurers, the investment strategy would incorporate their liability and asset positions. Thus, it makes sense for Japanese life insurance companies to increase their investment allocation to long-dated JGBs as yields rise,” Shunsaku Sato, vice president and senior credit officer at Moody’s Japan, told AsianInvestor.
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To reduce interest rate risk and duration mismatch between assets and liabilities, lengthening the asset duration by buying super-long JGBs makes sense. With a yield of super-long JGBs rising to around 1.5% or higher, it starts to match with Japanese life insurers’ average guaranteed yields for their insurance in-force policies.
The guaranteed yields are around 1.5% to 2%, in a steadily declining trend. Therefore, 1.5% to 2% super-long JGB yields are an ‘acceptable level’ for most Japanese lifers, according to Teruki Morinaga, director of insurance at Fitch Ratings Japan.
“We expect more Japanese insurers will buy super-long JGBs in an aggressive manner at current levels, while other Japanese lifers may wait until the yields exceed 2%. It depends on each insurer’s own market view,” Morinaga told AsianInvestor.
He emphasised that Fitch does not have a specific house view on JGB yields towards 2023. However, assuming that the global fear of inflation weakens in the next year, JGB yields may also decline from current levels, Morinaga elaborated.
WRONG DIRECTION
Recently, yields seem to be on the decline. Since its peak at 1.632% on October 25, the super-long JGBs has hovered around the 1.5% mark and closed at 1.473% on November 15.
As Morinaga pointed out, that yield level is not enough for all Japanese life insurers, and among the more skeptical is Nippon Life.
"It's true that it's [been] the easiest environment to invest in for the past several years," a representative of Nippon Life, also known as Nissay, said on October 24. "Because yields are at 1.5%, if the question is whether we can now buy actively, we're still a long way from that point."
Japanese life insurers’ appetite for super-long JGBs is heavily correlated with yield.
“If yields exceed 2%, we expect the speed of accumulation will accelerate, but if yields decline well below 1.5%, then the speed of accumulation will become slower again,” Morinaga said.
OVERSEAS PIVOT
About 40% of the rated insurers’ investments are in domestic bonds, comprising about 85% in JGBs, according to Moody’s Japan’s Sato. Morinaga at Fitch Ratings pointed out that as of end-March 2022, JGBs made up about 34% of invested assets among Japanese traditional life insurers, while foreign securities made up around 30%.
This domestic preference has only increased with the depreciation of the yen and the higher hedging costs of investing abroad, which have wiped out a big share of the yields. Still, Japanese life insurers must look for alternatives to super-long JGBs if the 1.5%-or-higher yields don’t stick around.
The obvious alternative investment targets will be foreign — mainly US — credit products such as corporate bonds with currency hedging. The yields on these products after currency hedging have become attractive recently, due to expanding credit spread in the US credit market.
“Japanese lifers need to earn a decent investment spread, so higher yield after currency hedging matters. Also, the capital charge for fixed income is low enough, so it makes sense to buy attractive US credit products with currency hedging, as long as these products provide attractive yield,” Morinaga said, elaborating that the yield should be “well above 2% after currency hedging.”
“Major life insurers are also accumulating alternatives, such as private equity and hedge funds, but the allocation will continue to be small,” Morinaga said.
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