As Japan insurers flirt with foreign bonds, yields may move more than yen

Thu Apr 25, 2013 10:45am EDT

* 'Abenomics' effects boost interest in foreign bonds without FX hedges

* Yen bond buying to slow, crowded out by BOJ as QE kicks in

* Volatility, low yields also sap insurer interest in JGBs

* But no drastic moves seen, yen not expected to fall much further

By Chikako Mogi and Hideyuki Sano

TOKYO, April 25 (Reuters) - Japan's life insurers, potential global market movers with $3 trillion in assets, have signalled they may boost their holdings of foreign bonds without currency hedges to the highest in five years, which could depress both overseas bond yields and the yen.

But annual investment plans for the fiscal year from April 1 suggest that, while the Bank of Japan's quantitative easing will squeeze them out of domestic bonds and into U.S. and European debt, they will make no drastic moves and will remain cautious on currency hedging. That means their investment strategies will likely have only a limited impact on the yen.

"If there is appropriate timing, we would like to boost our allocations to unhedged foreign bonds," said Hiroshi Ozeki, general manager of the finance and investment planning department at in Nippon Life Insurance Co, Japan's largest non-state life insurer.

Japanese life insurers, with a collective 332 trillion yen ($3.34 trillion) in assets including $1 trillion state-owned behemoth Kampo Life, had been a key force underpinning the dollar until 2007.

But the dollar's slide to record lows against the yen over the next five years, in the wake of the financial crisis, eroded their profits and left them wary of taking on currency risks.

As the BOJ now elbows them out of the domestic bond markets - which are anyway looking less attractive with higher volatility and paltry yields - and with monetary easing putting the yen's uptrend into the rear-view mirror, insurers look ready to wade further into the foreign bond markets.

Nearly all of Japan's top nine insurers, in interviews with Reuters or in news conferences over the past two weeks, said they were either planning to - or at least considering - boosting their exposure to foreign bonds.

Meiji Yasuda Life Insurance Co, with total assets of about 30 trillion yen, said it tentatively plans to buy about 500 billion yen of foreign bonds this fiscal year, or nearly half its targeted increase in assets for the year.

Others among Japan's conservative life insurers were less committal in their comments, but their interest in foreign bonds was unmistakable.

"If domestic bond yields stay at low levels for a long time, we may have to consider the need to shift to foreign bonds," Iwao Matsumoto, general manager of investment planning department at fourth-largest Sumitomo Life Insurance Co, told a news conference.

The 10-year Japanese government bond yield sank to a record low of 0.315 percent after the BOJ's April 4 announcement that it would nearly double its balance sheet in two years, mostly by buying government bonds.

The bond yield has since bounced back to around 0.6 percent, but trade remains volatile.

Many insurers said they prefer big, liquid markets, such as U.S. Treasuries and German bunds, although analysts said French bonds are increasingly popular for their hefty spreads as are other high-rated euro zone countries, such as the Netherlands.

CURRENCY HEDGING

Insurers were also uncharacteristically willing to consider leaving more of their foreign bond holdings unhedged, as the BOJ's strong reflationary commitment - a pillar of the "Abenomics" stimulus policies of Prime Minister Shinzo Abe - pushed the yen to four-year lows versus the dollar. That has eased the long-running risk that currency appreciation will erode the value of their overseas assets.

"If there are clear prospects for the yen to fall further, then we may consider lowering the ratio of hedged foreign bond buying a bit," Takahiro Ono, Asahi Mutual Life Insurance's chief portfolio manager, told Reuters in an interview.

The sixth-ranked Japanese life insurer, which had kept its foreign bond holdings fully hedged, was coaxed by the weakening yen to trim its hedging ratio to about 90 percent by the end of the fiscal year to March 31.

But yen bears looking for more yen weakness, and hoping that insurers' foreign bond purchases might accelerate that, will likely be disappointed.

The insurers mostly saw limited room for further declines and will likely continue putting currency hedges on the bulk of their foreign bond purchases. The cost of hedging also remains marginal with interest rates low in many parts of the developed world.

Nippon Life, with some 50 trillion yen in assets, believes the yen has already substantially priced in the BOJ's easing effects. It held about 6.64 trillion yen in hedged foreign bonds and 2.11 trillion yen in unhedged bonds at the end of March.

And while expectations of a shift in Japanese money to overseas bonds have already helped to bring down yields in the United State and Europe, while keeping the yen under pressure, actual capital flow data in recent weeks serves as a reminder that the talk of foreign bond buying is, still, just talk.

Finance Ministry data on Thursday showed that Japanese investors sold 862.6 billion yen worth of foreign bonds last week, for a sixth straight week of net selling.

Insurers will also be watching a variety of risk factors, such as whether the Japanese government bond market stabilises or global economic growth picks up, in deciding how much money to send abroad.

"Growth prospects in the U.S. and China must become solid to provide an environment for life insurers to take medium- to longer-term risks on foreign currencies," said Yunosuke Ikeda, senior currency economist at Nomura Securities.

And while the insurers all expected their pace of JGB buying to decline this fiscal year, those bonds will remain at the core of their holdings, since they are counted as risk-free assets for regulatory purposes and serve as the most suitable assets to match against long-term liabilities to policy holders.

"The feeling is that we have no choice but to buy, whether we want to or not," said Sei Sugimoto, head of investment planning at fifth-largest Mitsui Life Insurance.