The head of investments at one of Japan's largest asset owners says a looming slowdown for the global economy could help rather than hinder his organization's goal of boosting allocations to risk assets in coming years.
"I believe we've already entered a bear market from October" and that could provide opportunities now to add to the portfolio's holdings of U.S. investment-grade bonds, said Atsushi Tachibana, managing executive officer of the ¥74.8 trillion ($657 billion) Japan Post Insurance, Tokyo.
The insurance giant released a medium-term strategic plan on May 15 for the three years through March 2021, which included the goal of lifting its investments in return-seeking assets — such as foreign bonds and stocks — to 15% of the portfolio from 12.3% as of March 2018, a boost of roughly ¥2 trillion. Japanese government bonds have topped the list of asset classes experiencing a drop in allocations.
In recent years, U.S. bonds, including investment-grade and high-yield paper as well as bank loans, have been a prime target for Japanese institutional investors switching out of domestic government bonds offering zero or negative yields.
But the continued rise of U.S. interest rates this year boosted the costs of hedging dollar bonds back to yen to 2 to 3 percentage points, erasing much of the yield advantage on offer from U.S. bonds. That, in turn, has sharply reduced flows this year from Japanese investors, according to money managers.
Mr. Tachibana pointed to the maturity of the current economic cycle, inventory adjustment pressures globally and growing caution among Chinese consumers as signs suggesting a period of soft economic conditions has begun. That, in turn, could provide an opening for Japanese institutional investors struggling now to find yield, he said.
Hedging costs may be a big obstacle now but they're a short-term phenomenon and "we invest for the long term," Mr. Tachibana said.
While it's unclear when economic weakness will prompt monetary policymakers to begin easing, the likelihood of that happening in the next two years is considerable, Mr. Tachibana said. "If you look at the cycle, this is the best time to buy" — locking in attractive yields and ultimately benefiting when falling rates reduce hedging costs and spawn capital gains, he said.
Japan Post Insurance's latest results for the Sept. 30 first half of its fiscal year ending March 31, 2019, showed the portfolio boosting foreign bond allocations by roughly $1 billion a month for the half-year period.
As of Sept. 30, foreign bond holdings rose to ¥6.25 trillion, or 8.4% of the portfolio, from ¥5.55 trillion, or 7.2% six months earlier. That ¥700 billion increase accounted for most of the portfolio's ¥727.1 billion rise in risk assets to 13.6% of the total from 12.3%. An incremental boost in foreign and domestic stock valuations accounted for the remainder, Mr. Tachibana said.
The investment chief conceded that the U.S. economy continues to fire on all cylinders. Even so, the very strong momentum there now — as evidenced by expansionary Purchasing Managers index readings of close to 60 — should increasingly be hard to sustain, Mr. Tachibana said. He said November could prove to be the current cycle's peak for long-term U.S. interest rates.
China, meanwhile, is "a very important part of my outlook," said Mr. Tachibana, who predicted the profound changes underway there now — moving to an economic model reliant on domestic demand from an export-driven model — "won't be simple."
With the pace of change rippling through the economy picking up, China is facing the kind of structural change Japan had to grapple with when its "bubble economy" burst in 1990, said Mr. Tachibana. While China may be positioned to "address the situation a little more expeditiously," it will still be hard pressed to resolve issues such as the country's huge bad debt totals, and an unprecedented level of consumer caution there now will only add to the challenges, he predicted.
Meanwhile, if a looming economic slowdown allows Japan Post Insurance to continue adding to its holdings of investment-grade bonds, external managers may have less to cheer about than in previous years.
Japan Post Insurance's investment team, which had managed foreign sovereign bonds internally for years, began managing a portion of its foreign investment-grade holdings as well since the April 1 start of the current fiscal year, Mr. Tachibana said. He declined to provide details regarding the ¥6.3 trillion foreign bond allocation's sovereign-credit split.
At present, external managers oversee roughly ¥1 trillion of foreign credit-related exposures, and Japan Post Insurance will likely keep those mandates in place, said Mr. Tachibana. And while the internal team could pick up much of the continued increase in U.S. investment-grade holdings, the portfolio may still rely on external managers for allocations to areas such as bank loans and high yield bonds, as well as European, Asian or Chinese corporate bonds, he said.
Chinese government bonds offer interesting opportunities, although the costs of hedging them back to yen remain extremely expensive for now, Mr. Tachibana said. Longer term, China's currency will likely appreciate but short-term volatility could be huge, he noted.
Elsewhere, the insurer has continued to ramp up its move in alternative asset classes, with a focus on fund-of-funds vehicles.
Mr. Tachibana said his team is investing, quietly, through the market cycle and by 2020 is likely to have parked 1% of the portfolio, or roughly ¥750 billion, in alternatives, including hedge funds of funds, as well as private equity funds of funds.
Japan Post Insurance now is making direct investments in private equity funds in a joint venture with sister company Japan Post Bank, contributing ¥30 billion to JP Bank's ¥60 billion. To do that on a broader scale will require further increases of investment talent, Mr. Tachibana said. It's unclear whether the team will be ready to do so by 2020, but if possible, it would be desirable, he said.