The Japanese bid in a Japanified world
Japanese investors have been among the biggest supporters of Australian dollar and Australian-origin issuance in the rates, credit and structured-finance markets. In their annual roundtable, conducted in Tokyo in September, KangaNews and Mizuho Securities (Mizuho) found the Japanese buyer base is still supportive of Australian issuance but declining yield is a tough hurdle to overcome.
Leong How challenging are investment conditions at the back end of 2019, and how – if at all – have Japanese investors revised their views on Australian product in response to the contemporary environment?
Our view is that trade tensions between the US and China will affect the Australian economy. As a result, going out to 2020 we think Australian government bond yields will continue to soften. We will not change our stance but we have seen inflows to our Australian insurance products decreasing. This is why we are not currently investing a lot in Australian dollars.
The recent increase in volatility has been forcing some spread widening. However, prolonged monetary easing is likely to increase the need for credit on the part of investors like ourselves in the insurance sector, so we will continue to invest in credit in line with funds inflows.
We invest in the Australian market via various asset classes. In recent years we have focused on expansion in the credit market. In this context, we welcome the fact that Australian dollar tier-two issuance is increasing as the total loss-absorbing capacity (TLAC) regime is starting.
Versus US dollar issuance, Australian dollar additional tier-one (AT1) bonds that have been issued this year by the likes of UBS Group and BNP Paribas may be a little bit expensive. However, it is very encouraging, especially from an Asian private-bank perspective, to be able to invest in these bonds issued by global names in Australian dollars.
The TLAC bonds issued in Australian dollars by international banks are also a good development. We saw a five-year deal from MUFG Group this week, for instance.
The four major Australian banks are likely to issue a greater amount of tier-two bonds going forward and the market for this type of issuance will definitely expand. We expect the mainstay of credit to shift towards tier-two from senior bonds.
But single events so far have not been an issue. Of more concern are matters of ongoing uncertainty – such as Brexit in Europe. It is difficult to forecast the future with this kind of event. In this regard we have started to tone down our investments in some cases – sometimes foregoing potential investments and sometimes delaying the timing of investments. I note, however, that this stance is about credit investment outside Australia.
However, I would say that it is possible things are too good to be true right now. This means we are maintaining some exposure in the Australian market for the time being but we are also thinking about switching to the US from Australia.
We prefer semi-government securities in the Australian bond market. This is due to regulation change by the Australian Prudential Regulation Authority (APRA). Some of the banks have to hold semi-government securities, with the result that they are an attractive asset for us to hold, too.
As for trade tensions, the impact has not occurred as yet but we are keeping a close eye on how things evolve given Australia has a lot of relevance to the Chinese economy.
“We are still quite asset-hungry and resilient to the Australian market – especially for investments like RMBS. On the other hand, we don’t have any onshore branches in Australia or ‘natural’ Australian dollars to invest – so we are conscious of the high cost of Australian dollar investments at the moment.”
If there’s one issue that may cause problems, it’s declining house prices. I understand that prices have picked up for the first time in two years, which is positive and has been helped, I think, by the rate cuts from the Reserve Bank of Australia (RBA). However, personal consumption is not very strong so at this point we are watching carefully how things develop.
Davison In securitisation, are Japanese investors still focused on prime RMBS issued by major banks or are their interests also diversifying?
Another important thing to note is that issuance from the four majors has slowed down recently, which is very different from the nonbank sector. This is another reason we would look more towards the nonbanks if we were to start investing in Australian RMBS.
We think there is a difference in the risk level between banks and nonbanks. The seasoning and prevalence of investment loans are very different when you look at the two types of issuers. Liquidity of RMBS is also different. These differences translate into a spread differential. For this reason we are mainly looking at ADIs when we consider RMBS investments, though we also consider relative value.
Davison RMBS might fit quite well with asset-hungry investors as it provides good yield relative to other product in the same ratings band. As the Australian cash rate falls, does RMBS become more or less attractive?
On Australia specifically, previously the four major banks and some large ADIs were the only products we could invest in. However, we will also probably look into the prime products of nonbank issuers given the expected position of relative spreads going forward.
Leong Ishide-san, you mentioned AT1 product from international banks in Australian dollars earlier in this discussion, in the context of decreasing yields globally. Do you think it is becoming more difficult for Japanese investors to find the absolute return they need?
AUSTRALIAN DOLLAR FLOWS
Swiss At this discussion last year we heard that Australian dollar inflows had thinned in the life-insurance sector, in favour of US dollars. How, if at all, have currency preferences changed in the past 12 months?
We use a sales channel to market insurance policies. This means there is always a time lag to place product because we have to educate the sales team. Even so, we have started to see a shift towards US dollar denominated product. Customers also tend to be a bit more familiar with US dollars.
We note, however, that engagement with Japanese investors is not just an Australian dollar story but a wider multicurrency and multimarket approach. Japanese investors are the largest in the Asia-Pacific region, individually and on an aggregate basis. In addition to yen, they are prepared to invest meaningful volume in US and Australian dollars and, more recently, euros. We have seen them in a high proportion of Australian credit deals this year, in multicurrency public and private formats.
Leong It sounds like the trend for decreasing inflows to Australian dollars has just started. Is this likely to continue as the education process is still working its way across the sales channels?
We are also seeing declining demand for US dollar denominated products. Whether it’s US or Australian dollars, we don’t expect rates to continue to come down and they still look better in comparison with other regions. In this respect we target a return over a longer period so we will still invest in products denominated in these currencies.
Our house view forecasts that the Fed will cut rates once more in 2019 and the RBA will also cut the cash rate to 0.75 per cent this year. The spread between Australian and US bonds currently favours US dollar investments. For instance, the spread differential in 10-year bonds is around 60-70 basis points. This is why we would invest in US dollar bonds rather than Australian dollar bonds.
In the last two years, I have observed that emerging currencies, such as Mexican peso and South African rand, have been beaten around. The Australian dollar sits between these emerging currencies and the major currencies.
Once the Fed becomes more aggressive in cutting interest rates, the situation of the Australian dollar being weak against the US dollar will probably reverse. This will be good for Japanese investors as we will be able to capture the capital gain from the currency side.
AUSTRALIAN DOLLAR SUPPLY
Davison The Australian Office of Financial Management (AOFM) is on a forecast path of falling net new issuance while the Australian states are generally expecting to issue more bonds in the future. How do supply factors affect the demand outlook?
Whenever we need to replace investments in ACGBs, we may have to take duration risk if there is not sufficient issuance. This supply-demand issue would be eased if we saw more issuance by the AOFM.
As a result, the AOFM has said it will reduce exposure in the very long end of the yield curve. On the other hand, the short end of the yield curve is moved more by expectations concerning monetary policy.
I’m not concerned about a spike in fiscal deterioration. Having said this, we need to compare sovereign issuance to other sectors like semi-governments. As I have mentioned previously, there is always demand from banks for semi-government bonds. We put money into this sector as a result.
Nevertheless, we are sometimes selective among the semis. Right now, we prefer the smaller names like Western Australian Treasury Corporation and even at times Tasmanian Public Finance Corporation.
Although the semi-governments don’t have a direct guarantee from the Commonwealth government, I think there is an implicit government guarantee. The issue we see sometimes is difficulty in the secondary market because investors don’t want to sell as long as the Australian bonds bear higher yields.
As a result, we have to be in the primary market to capture the opportunity in semi-government bonds. This doesn’t just apply to Australia – it is the same in New Zealand. We need to be in the primary market to buy New Zealand Local Government Funding Agency bonds.
Swiss Do you receive sufficient allocations when you want to invest in Australian or New Zealand semi-government bonds?
The circumstances global markets are confronting – of ultra-low and even negative rates, low growth and seemingly endless stimulus – are a way of life to Japanese investors.
TAKEI A relevant theme here is demographics. The Australian economy is starting to reflect an ageing population. In this sense, we have some experience because Japan is the first country globally to experience this rapid ageing. The reason for this is that the baby boom after World War II lasted three years in Japan, whereas in the US it lasted almost two decades. We are the first country to experience the ageing of that population group.
An ageing economy implies that potential growth rates are heading south. This means it is very hard to see a ‘rock-star economy’ coming back to advance the situation in Australia.
On the other hand, a couple of years ago I thought Australia would join Japan’s camp of zero or negative rates. But actually Australia is still in a lucky position – there is still at least some positive cash rate in reserve. This will probably not be the final destination, though, so we have to think about a negative interest-rate policy and QE as well.
Leong Do investors expect to be significant buyers of Australian-origin tier-two bonds as supply increases with local TLAC regulation? Will demand be focused on Australian dollars, US dollars or other currencies?
This could change if tenor evolves. Australian banks’ tier-two bonds in Australian dollars tend to be 10-year non-call five product. These bonds may not be attractive for investors that require longer duration. If there is more variety in structures from the Australian banks – such as 15-year non-call 10 deals like those that have been issued in US dollars – it will likely generate new demand from Japan.
In this respect, some investors are more careful when it comes to tier-two bonds – whereas I think tier-three bonds are regarded effectively as senior securities by most investors. The point is that some investors may have specific limits in relation to subordinated product, which would apply to tier-two but not to tier-three. This may cause restrictions to some extent.
On the other hand, the four major banks in Australia are considered to be relatively safe. In this respect we would consider looking at tier-two issuance from the major banks in US dollars and possibly even yen.
AUSTRALIAN DOLLAR ISSUERS IN JAPAN
Davison What role have Japanese investors played in Volkswagen’s Australian dollar debt products – vanilla bonds and asset-backed securities (ABS) – historically, and how has this demand evolved?
Japanese investors have been relatively limited in the unsecured bonds, partially due to the volume limitations of corporate issuance in the Australian domestic market. When it comes to ABS, however, a lot of Japanese investors have shown interest and we have had a number of noteable Japanese investors come back repeatedly with decent appetite, especially in the past couple of years.
We have issued five Driver ABS deals in Australia, with the next one coming in October. These are seasonal deals which offer good spreads – the last deal was 93 basis points over one-month bank-bill swap rate for the class A notes and 150 basis points over the class B notes.
As a matter of fact, we have had some Japanese investors come to our offices in Australia to conduct due diligence. They like the fact that our ABS deals are scheduled, annual deals. This is different from our vanilla bond issuance which is not so programmatic. Demand is pretty consistent. In fact, it has been growing despite the fact that there are headline risks in our sector that can cause sentiment to change overnight.
Leong What led Central Nippon Expressway Company (CENEXP) to print in Australian dollars and is this a market you will return to in the future?
Swiss Would CENEXP consider creating a Kangaroo bond programme to encourage more Australian investor participation?
Davison What role does the Japanese investor base play in SGSP Australia Assets (SGSPAA)’s debt book?
In these last four years we have seen a very healthy trend. We have seen the initially narrow flexibility of Japanese investors broaden significantly – via currency, duration and credit. We now have a very healthy relationship with a handful of key accounts in Japan that we visit every year. They participate in our Australian dollar and Reg S US dollar bonds as well as private placements (PPs).
Japan is a key part of our investor-update story and investors from Japan form an increasingly important part of the liquidity conversation for us. General representation on our deals – regardless of currency – has increased to 6-10 meaningful accounts from one or two.
Leong As we’ve heard today, cash rates are so low that Australian dollar investments might be increasingly difficult for some of the investors around the table. David Gillespie, you have talked about consistent support from Japanese investors but are you confident this will continue?
From our perspective, there’s a settling of expectations around yield that happens whenever there is a rate change, following which we continue to see fruitful engagement. Supporting this view, our PPs in 2019 have very much been anchored by Japanese investors.
Swiss Where do Reg S US dollars fit in to SGSPAA’s funding mix, and what role to Japanese investors play in these deals?
The way we look at Asian investors as a whole – and this applies across issuance types – is that the Asian investor base is in many respects equally as important to us as the Australian domestic investor base. Australian dollar issuance will always be a mainstay of our funding programme. But US dollar Reg S now includes our largest outstanding bond line and is our most liquid curve. We see this market typically providing US$500 million benchmark issuance at 10-year tenor.
The nature of the investor mix in Reg S has changed. Our first deal, in 2014, was heavily biased towards Europe and a lot of the anchor orders in our second deal still came from the UK. The last two transactions, by contrast, have been dominated by the Asian bid.
Breaking down Asian distribution, when we first issued there was a lot of concern around hedge funds and hot money. It is quite the opposite nowadays, with a lot of high-quality accounts from Hong Kong, Singapore and Japan that will buy us in Australian and US dollars as well as exhibiting PP interest.
Davison Historically, markets tended to divide Asia into Japan specifically – as the most developed market – and Asia excluding Japan. Is market development facilitating a pan-Asian investor-relations approach?
We update across currencies, deal formats and structures. This is one of the reasons why the Asian investor base, including in Japan, is so important to us: because many accounts in the region are able and willing to support us in many formats and currencies.
Given the size of our debt book, we have the advantage of being more able to build curves than many of our domestic peers. We are able to commit to frequent issuance in public markets as well as some of the PP activity we undertake. We can say to investors that we are always going to come back.
Japan and ESG – still a work in progress
The Japanese buy side has a similar position on sustainability as a component of investment strategy as it did a year ago: growing interest, but little imminent sign of mandate change.
KATAGIRI Interest is increasing but when we make an investment decision ESG does not play a part – we just look at the investment itself. Having said this, we do look at ESG scores and ratings. But we use them as a tool in scenario analysis for stress tests, rather than being embedded in our internal rating scheme.
ISHIDE There has been more issuance of green and social bonds over the last few years. However, like many other investors we don’t segregate ESG bonds from others – we don’t look at them separately. For example, the MUFG Group deal done this week was a green bond, but we viewed it simply as a corporate bond.
Companies want to make a greater contribution to society and be more respectful of the environment. In this sense, when we make an investment we screen its potential based on ESG scoring. This is one of the investment criteria we look at.
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