A series of investor roadshows slated for this year and hosted by the Japanese ministry of finance (MoF) will aim to stimulate foreign investor activity in the yen-denominated bond market. However, what makes the government’s task so different – and difficult – compared with roadshows undertaken by the US Treasury or UK Debt Management Office is that, in Japan’s case, the starting point is from far further back.
Figures from the Bank of Japan (BoJ) confirm this: in the fourth quarter 2007, international investors owned just 6.6 per cent of Japanese government bonds (JGB). Contrast this holding to foreign investor exposure in the home markets such as UK gilts (30 per cent), US Treasuries (44 per cent), or in bonds raised by the Agence France Trésor (50 per cent). In fact, foreign investors have about as much sway in the market as Japanese households do, given they owned about 6 per cent of total JGB outstanding last year.
Speaking to FT Mandate on the eve of a major UK roadshow, Kazuo Katayama, head of debt management at Japan’s MoF in Tokyo, believes yen-denominated products on the long end of the yield curve are appealing to a wider investor base like European pension funds and fixed incomes houses.
“European pension funds want our super-long bonds for their liability-driven investment strategies, hedge funds want the arbitrage on 20 and 30-year notes and Japanese institutions want the liquidity on shorter term notes,” he says.
Super-long JGBs have maturities of up to 40 years and offer higher yields (2.35 per cent as of February 1, 2008) than the more liquid five and 10-year issues that currently return around 0.95 per cent/1.5 per cent. However, these yields are certainly weaker and less appealing to the investor when placed against 10-year US Treasuries (3.65 per cent) and 10-year UK gilts (4.5 per cent).
Last year the MoF held JGB roadshows in 19 cities, including London, Moscow and New York, and visited Middle East and Asian finance centres. This year, it intends more of the same, says Mr Katayama. “We are planning to take the European tour from the end of February to early March, then to North America in May, and the Middle East and Asia/Oceania tour in the summer.”
The amount of outstanding JGBs at the end of March 2007 was ¥671,000bn (€4240bn, $5900bn), and is expected to be ¥688,000bn in March this year. However, the figure for net issuance is a better guide to assessing which direction the market will take in the next 12 months. According to Mr Katayama, issuance for 2008 is expected to be around ¥25,300bn, from ¥25,400bn last year and about a third lower than in the mid-2000s when JGB issuance was typically ¥34,000-¥36,000bn.
Balancing liquidity
But if the level of new bond issues piloted by Mr Katayama is on a downward trajectory (the government has stressed the need to rein in borrowing and balance the budget by 2011), how will this support his ‘world tour’ of fixed income houses and pension funds?
“Though we are pulling back on certain bonds – like 15-year floating rate bonds, which are less suited to the current demands for long-dated notes, especially from pensions – we’re increasing the supply of super-long bonds to compensate and rebalance liquidity,” he says.
The MoF is also mounting a buyback campaign, and looking to get around ¥9000bn of bonds issued mainly to financial institutions back on its balance sheet. “Financial institutions in Japan that purchased the 15-year floating rate bonds, when their prices were higher, have kept losses on their balance sheets as a result. These financial institutions are rather fed up with these bonds now. We would expect the reduction in issuance and the buyback increase to function together like the two wheels of a cart,” Mr Katayama adds.
Neil Davis, director of debt sales at Daiwa Securities SMBC, the Japanese-owned investment bank, confirms that foreign money is slowly returning to the JGB market but says there are significant “stumblers” to it catching up gilts or US Treasuries. “For one, absolute yield levels have been in the narrow range of 1-2 per cent since 2003, with spreads anything up to 300 basis points between 10-year JGBs and 10-year Treasuries,” he says. Logically therefore, on yield alone, investors are more likely to overweight US Treasuries than JGBs.
For absolute yields on JGBs to tick up, the key interest rate (currently 0.50 per cent) set by the BoJ will need to rise – which is highly unlikely according to Grant Lewis, head of fixed income research at Daiwa. “Not a chance in our view. The yield curve remains flat and the economic fundamentals (wage and price inflation are virtually zero) point to rates staying put or even being cut,” he says. According to a recent survey of economists, there is a 25 per cent chance of the BoJ cutting its benchmark rate to 0.25 per cent by June 2008.
“The good news is that everything is in place for a recovery in the JGB market – certainly compared to conditions in 1997,” says Mr Davis. At that time, following the Asian currency crisis, Japan went through recession and a period of corporate/banking restructuring, which interrupted the flow of funds into the bond market, with both domestic and foreign buyers lukewarm about holding JGBs.
Alternative channels
Bond liquidity in Japan does have alternative channels in which to flow, other than through the government market. For example, the municipal bond market was a surprise hit in 2007, as greater international demand and interest from European and US bond houses was acknowledged.
On the sell-side, municipalities, or local authorities, have sought to raise finance for public works, instead of asking the fiscally conservative central government for money, via the bond market. Total issuance for 2007 was around ¥6000bn, and is expected to rise to ¥8000bn in 2012.
Government changes to withholding tax, abolished for foreign investors since January, are expected to facilitate investment exposure to the municipals market in the long run. Coupons received by non-resident investors are now exempt from the 20 per cent withholding tax. But like the JGB market, which also has had issues relating to tax and settlement for foreign bond investors addressed in recent months, its development has been staggered and uneven for the majority of market makers.
 | “To be honest, the market has gone to Japan, rather than Japan going to the market,” says Brian Lawson, co-head of equity & fixed income syndicate, at Nomura. A number of European public finance banks, such as Germany’s Depfa bank, have sought Japan municipals exposure recently, despite the lack of credit ratings for local authority issuers. |
And there is a suspicion that the lack of long-dated paper in Europe could strengthen the Japanese municipals market further, believes Mr Lawson. “The domestic market retains a strong appetite and tighter spreads, usually 10 basis points under JGBs of similar duration. This is of particular interest to investors,” he adds.
Another route to gaining yen-denominated bond exposure is through covered bonds. Shinsei Bank, which last month received a triple-A rating from Moody’s for its ¥50bn bond, is the first issuer of a covered bond in Japan and this debut, hints Mr Lawson, bodes well especially for a product that is established in Europe and the US. “Shinsei could prove a stimulus to this asset class,” he adds.
Chotaro Morita, chief fixed income strategist at Barclays Capital Japan, suggests the banking sector could be the first to amble back to the JGB market in 2008, given the macroeconomic climate is becoming more accommodating. “Banks had been reducing their holdings in anticipation of rate hikes and more corporate demand for loans. However, the environment has changed expectations for monetary policy and loan demand and we now see banks increasing JGB exposure, but still cautiously,” he says.
Cheap finance
Koyo Ozeki, executive vice president at Pimco, echoes this sentiment, while referring to last year’s subprime blowout: “Liquidity is flush in the market and we cannot foresee a systemic risk as in the US and Europe that might upend the credit markets as a whole,” he says. “Japanese corporate bond markets offer the cheapest means in the world at present for issuers to raise money, and we expect the volume to increase.”
Both bond managers Pimco and Blackrock have significant fixed income allocations in the region. “The impact on the debt market has been moderate compared with other markets, reflecting the fact that the balance sheets of Japanese banks remain healthy and Japanese corporations have not procured funds excessively,” adds Mr Morita.
The increasing popularity of samurai bonds – bonds issued in yen by non-Japanese finance houses such as Citigroup and Bank of America – could also offer spike for non-JGB activity over the course of 2008.
“The range of issuers considering samurai finance is growing quickly, given dislocations in other sectors,” says Nomura’s Mr Lawson. About ¥927bn was issued in September 2007, a boom time for the market just as the availability of credit in the US and Europe was drying up. And an interesting footnote might be the possibility of sovereign wealth funds flexing their muscle in the Japanese bond market in 2009, following advances made in Japanese equities this year.
