Japanese insurers look to domestic bonds as yield gaps with foreign peers narrow

By Tomo Uetake

(Reuters) - Japanese life insurers, among country's largest institutional investors, are returning to the domestic bond market after many years of forays into foreign debt as the yield gaps between them have shrunk following the COVID-19 pandemic.

Many of them plan to increase their holdings of domestic fixed income assets while planning to reduce those of foreign debt in the second half of the current financial year to March, officials said at news conferences or in interviews with Reuters.

"We have long been investing primarily in U.S. dollar bonds but now that their yields have fallen to so low, we are not in a position to buy them aggressively anymore," said Koichi Nakano, general manager for investment planning at Meiji Yasuda Life.

Foreign bonds have been a major source of income for Japanese institutional investors who had been deprived of interest income at home due to the Bank of Japan's hyper-easy monetary policy.

The coronavirus outbreak and subsequent monetary easing around the world to shore up battered economies, however, knocked down bond yields in the United States and elsewhere, shrinking the yield gaps between Japan and the rest of the world.

The 10-year U.S. Treasuries yield , having slumped to a record low of 0.318% in March, has stayed mostly in 0.5-0.8% range in the current financial year.

Many investors are turning cautious about holding foreign bonds without currency hedges, as they expect the dollar/yen could weaken following the dollar's broad decline in the middle of this year.

With hedges, returns from U.S. bonds, the mainstay of Japanese investors, are more depressed.

The cost of hedges with three-month currency forward contracts has been more than 0.50% per annum in the current fiscal half, though it can vary, depending on time, currency and instruments they use.

BACK TO HOME

Five of the top ten insurers Reuters talked to said they will reduce sovereign debt, or foreign bonds in general, while only one saw an increase in holdings of foreign currency debt.

Six insurers look to increase domestic bonds, with only one having an explicit plan to reduce them.

"We plan to increase the holdings of Japanese government bonds (JGBs) regardless of market environment. But if their yields rise further, we could consider accelerating buying," said Akifumi Kai, general manager of investment planning at Dai-ichi Life.

Yields on long-dated JGBs have edged up lately as the BOJ has been quietly trying to talk up superlong bond yields to mitigate damages to the country's yield earners, such as insurers and pension funds.

The 20-year yield has risen above 0.40% , compared with a three-year low of 0.015% hit in September last year.

Many of them expect market volatility after U.S. elections on Nov. 3 though Sumitomo Life [SMTLI.UL] and Japan Post Insurance <7181.T> said they are keen to buy stocks when the market corrects.

Japanese insurers are also stepping up adoption of ESG (environmental, social and governance) investing.

Nippon Life, the industry leader, said it will start incorporating ESG perspectives on all its investments, beginning in April next year. Dai-ichi said it expanded ESG to all its foreign stocks portfolio in September.

(Reporting by Tomo Uetake in Sydney and Tokyo Markets Team; Editing by Hideyuki Sano and Muralikumar Anantharaman)