Japan's insurers returning to foreign credit hunt
Japanese life insurers have resumed buying in the foreign credit market after nine straight months of net sells.
The purchases are driven by higher returns in the United States credit market, reflecting not only higher long-term interest rates but also higher credit spreads in investment-grade securities as well as stronger liquidity, according to the latest report by Moody’s Investors Service.
Against the backdrop of economic recovery, the 10-year US Treasury yield has climbed dramatically from 0.9% in December 2020 to hit a 14-month high of 1.776% in late March, before fluctuating to around 1.5% currently.
Meanwhile, although the interest rates of long-term and super long-term Japanese Government Bonds (JGBs) have been on the rise since September 2019, the highest yields are still below 1%, with the 40-year JGB yield standing at 0.72% on June 15.
The low interest rates for domestic bank loans have also led to limited issuanes of Japanese corporate bonds, which further fuel the search for better returns abroad.
Prior to the lifers’ market re-entry, data from Japan’s Ministry of Finance and Bloomberg showed nine consecutive months of net withdrawals from overseas bonds by the same Japanese insurers that lasted through March 2021, amid a low-yield environment.
THE A-GAME
Japanese life insurers tend to invest in A-rating range US corporate bonds, which allows them to benefit from higher yields while keeping overall risks manageable, Soichiro Makimoto, vice president and senior analyst of Moody’s Investors Service, told AsianInvestor.
The current average returns of offshore single-A corporate bonds range from 2% to 3% after accounting for currency hedging costs. Since hedges are considered reasonably priced due to the strong dollar (trading at ￥110.12 on June 15), some insurers have taken to cross-currency swaps to lock in such costs.
“Mega players like Nippon Life and Dai-ichi Life [have] already started to analyse US credit themselves, [and are trying] to invest more in single-A category corporate bonds,” said Teruki Morinaga, director of insurance at Fitch Ratings Japan. “They are still prudent in investing in triple B category bonds,” he added, noting these assets’ substantial risks of being further downgraded to double B.
“A limited number of large companies are investing in lower-rated, higher-yield corporate bonds,” Morinaga said, stressing that the lifers’ general appetite for credit will vary by size and investment capability.
“For medium- or small-sized Japanese insurers, to analyse foreign credit from Tokyo is not easy. To hire skillful managers outside Japan is also not easy,” Morinaga explained.
Noting that these smaller-sized insurers rely on US or European asset managers to select overseas securities, he believes they will continue to focus on easily analysed sovereign bonds like US Treasuries or Australian government bonds.
A SURE BET
Japan’s nine major life insurers have combined assets of ￥223 trillion ($2.02 trillion) as of March 2021. Traditionally conservative investors, the insurers allocate on average over 60% of their assets into fixed income – making them one of the world’s largest buyers of global bonds.
As of March, Japanese lifers’ average position in foreign fixed income was at 30%, JGBs at 33%, and domestic equities at 11%, according to Fitch Ratings.
Allocation to foreign bonds are likely to be kept at the 30% level, which has the highest risk-return efficiency, said Morinaga.
Life insurers that have already invested over 30% offshore might gradually cut allocation and optimise positions by moving from treasuries to corporate bonds. Those who are still below 30% in overseas fixed income are likely to continue to raise the total allocation for better yields, Morinaga told AsianInvestor.
Japanese lifers are enhancing risk management and lengthening asset duration in the face of a new economic value-based solvency regime in 2025. Under the new regime, a large negative duration gap – or mismatch between a lifer’s long yen-dominated liability duration and relatively short asset duration – can lead to higher risk charges.
“In the short term, I expect to see a redeployment of overseas fixed income purchases probably leaning closer to fully hedged strategies,” said Bart Wakabayashi, branch manager of State Street Bank and Trust Company Tokyo Branch.