Japanese investors reaction to low interest rate environment

some takeaways for Emerging Asia

Alicia Garcia Herrero, Chief Economist Asia Pacific
+852 3900-8680 , alicia.garciaherrero@ap.natixis.com

The views expressed in this presentation are the views of the author and do not necessarily reflect the views or policies of the Asian
Development Bank Institute (ADBI), the Asian Development Bank (ADB), its Board of Directors, or the governments they represent. ADBI
does not guarantee the accuracy of the data included in this paper and accepts no responsibility for any consequences of their use. Terminology
used may not necessarily be consistent with ADB official terms.

Dec 2016
 Government bond yields increasingly low
Japan: Asias frontrunner in ultra-low yields followed by Korea

Sovereign bond yield: 10Y (%) Policy rates (%)

JP SK JP SK
8 8
7 7
6 6
5 5
4 4
3 3
2 2
1 1
0 0
-1 -1
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016

2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
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Japanese portfolio investors have reacted to increasingly lower
rates by investing abroad, especially in debt securities

Portfolio investment (USD bn)

Total portfolio flows Of which: Debt securities

400 400

300 300

200 200

100 100

0 0

-100 -100

-200 -200

-300 -300
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Source: MoF, Natixis

Positive implies outflows

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Long-term debt securities dominating inflows

Portfolio investment (USD bn)

Long-term debt securities Short-term debt securities

400 400
350 350
300 300
250 250
200 200
150 150
100 100
50 50
0 0
-50 -50
-100 -100
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Source: MoF, Natixis

*Long term debt securities refer to bonds and notes, while short-term are money market instruments
Positive implies outflows
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US followed by EU countries favorite destinations of Japanese
portfolio outflows, not emerging Asia

Japan: Main destinations of outflows in 2016 Japan: Main destinations of outflows in 2016
(Long-term debt securities, in USD bn) (Short-term debt securities, in USD bn)
CAYMAN
GERMANY ISLANDS
ITALY BELGIUM THAILAND SINGAPORE
IRELAND
7
SWITZERLAND 3 9 8
4 3 SPAIN NETHERLANDS
26
4 2 4
AUSTRALIA U.S.A.
6 30

CANADA BELGIUM
12 30
AURALIA
LUXEMBORG 30
12
U.A.E.
U.S.A.
86 LUXEMBORG
FRANCE 121
28 436

*2016 data till Sep

Source: Natixis, MoF, Datastream

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Within Asia, dominated by Singapore. Hardly any flows to EM
Asia and not increasing with Japanese ultra-low rates

Main destinations of outflows in Asia

(Total portfolio investments, USD bn)

2012 2013 2014 2015 2016

80

70 USD bn 2012 2016* Change in outflow**

SG 72.6 29.8
60 TH 21.4 5.8
TA 0.1 1.1
50
ID 8.3 0.9
40 IN -0.2 0.9
PH 0.2 0.7
30 MA 0.9 0.6 -
VN 0.3 0.4
20

10

-10
SINGAPORE THAILAND TAIWAN INDONESIA INDIA PHILIPPINES MALAYSIA VIETNAM

*2016 data till Sep

** Comparison between 2012 and Jan-Sep 2016
Source: Natixis, MoF, Datastream

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No strong correlation found between Japanese portfolio
outflows into EM Asia and expected rate of return

Correlation between Japanese capital outflows and Correlation between Japanese capital outflow and
expected rate of return* exchange rate adjusted expected rate of return*
India 0.53 India
-0.04
Indonesia -0.71 Indonesia
-0.17
Malaysia 0.34
Malaysia
0.26
Philippines -0.03
Philippines
-0.37
Singapore 0.00
Singapore
Taiwan 0.57
0.68
Taiwan
Thailand -0.50 -0.48

Vietnam Thailand
0.16 0.02

* Expected rate of return is defined as the difference between
10Y sovereign bond yield of a host country against JGB yield
Capital outflow is the amount of capital invested by Japanese
banks in debt securities of targeted country
Data since 2005
Source: MoF, Bloomberg, Datastream, Natixis
* Expected rate of return is defined as the difference between 10Y
sovereign bond yield of a host country against JGB yield plus the
expected appreciation of host countrys currency against yen.
Capital outflow is the amount of capital invested by Japanese banks in
debt securities of targeted country
Data since 2005

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Interest rate differential would have warranted more
Japanese outflows into EM Asia but

Interest rate differential (local - Japan, in %)

India Indoneisa Malaysia Philippines Singapore Taiwan Thailand

16 16

14 14

12 12

10 10

8 8

6 6

4 4

2 2

0 0
05 06 07 08 09 10 11 12 13 14 15 16

Source: Datastream, Bloomberg, Natixis

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Not so much when taking into account exchange rate
expectations: Original sign type of problem?
Sum of rate differential (local - Japan) and expcted appreciation of FX of EM country against JPY (in %)
India Indoneisa Malaysia
10 10

5 5

0 0

-5 -5

-10 -10
05 06 07 08 09 10 11 12 13 14 15 16

Philippines Singapore Taiwan Thailand

10 10

5 5

0 0

-5 -5

-10 -10
05 06 07 08 09 10 11 12 13 14 15 16
Source: Datatream, Bloomberg, Natixis
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 Zooming into how different investors behave in an
ultra-low interest rate environment?

Focus on:

1) Japanese banks investment abroad

2) Japanese and Korean Pension Funds

Implications for Emerging Asia

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Japanese banks profits squeezed by narrowing margin of
domestic rates so need to move abroad to keep profitability

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Aggressively increase in overseas assets although from very low base

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Japanese banks cross border lending abroad quickly growing
but mainly into developed world

Japanese banks' claims against RoW in 2016 Q2

Japanese banks' claims on the world (US$ bn) (US$ bn)
1,400 Australia
Germany 85 Netherlands
95
1,200 HK 66
105
1,000 Luxembourg
106
800
Singapore
151 US
600 1,207

400 France
190

200
UK
0 295
2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016 Q1

Source: BIS, Natixis Cayman Islands

Source: BIS, Natixis 608

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Japanese banks cross border lending into EM Asia still small
but increasing, especially as Japanese rates get lower

Japanese banks' claims against EM countries Japanese banks' claims against EM Asia in 2016 Q2
(US$ bn) and 10Y yield of JGB (%) (US$ bn)
Philippines
30 Thailand Indonesia India 1.6 4
Malaysia
Malaysia Philippines JGB (%, rhs) Vietnam 7
1.4
25 7
India
1.2 17
20 1
0.8 Indonesia
15 19
0.6
10 0.4
0.2 Thailand
5 26
0 Singapore
0 -0.2 151

Source: BIS, Natixis

Source: BIS, Natixis

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Even with very low domestic rates, Japanese banks expansion
abroad at risk due to USD funding constraints

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As for Pension Funds: Japan (GPIF) ahead of Korea (NPS) in terms of
foreign assets but NPS expected to catch up by 2020

Asset allocation plan for Japan and Korea (%)

Domestic FI Domestic Equities Global FI Global Equities Alternatives

100%
6 10
12
90%
25
21 13
80% 20
4
70%
13 15 5
60% 20
20
50% 21 25
40%
30%
51
45
20% 39 35
10%
0%
Japan Korea Japan* Korea
Jun-16 Jun-16 Strategic allocation
(Korea: in 2020; Japan: Undefined)
* JP: Target undefined for alternative investment
Source: GPIF, company data, Natixis

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Koreas NPS also keener to invest in EM (especially Asia)

Korea: Global Equities by Region in 2015 Japan: Global Equities by Region in 2015

Africa/Middle LatAm Pacific Others

East 1% 4% 1%
3% Emerging
Markets
10%
Asia
17%

North America Europe

55% 25% North America
60%
Europe
24%

Source: Natixis, Compamy Data Source: Natixis, Compamy Data

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Koreas also more exposed to alternative investment, especially overseas

NPS: Strategy in Alternatives (USD bn) NPS: Asset in Alternatives (2015, USD bn)

60 35

50 30

25
40
Others
20
30 Global Private Equity
15 Infrasturcture
20 Domestic 10 Real Estate
10 5

0 0
11 12 13 14 15 Domestic Global

Source: Natixis, Compamy Data Source: Natixis, Compamy Data

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NPS doing better in terms of risk-adjusted returns
and recently even in terms of total returns

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 Some takeaways for Japanese and Korean investors reaction to
low interest rates domestically

Japans front-running position in the ultra-low rate environment has not so far resulted
in a large portfolio outflow into higher yield economies in Emerging Asia

Portfolio outflows into relatively low interest rate environments (US followed by EU)

Same conclusion when looking at different types of Japanese investors (banks and
pension funds) and especially so when compared with Korean ones (pension funds)

Fast increase in Japanese banks investment overseas mainly into US and EU and not
EM Asia notwithstanding high carry trade opportunities in many instances

As for pension funds, even if Japans GPIF has been living with low rates for much
longer than Koreas NPS it has remained more conservative.
This is specially true when focusing on their investment in Emerging Asia

The lack of Japans investors appetite for Em Asia assets, notwithstanding

ultralow domestic rates, may be a consequence of very high risk aversion,
especially to sovereign risk but also currency risk (seemingly more than
Korea).

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