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The Japan bond market is back on investors’s radars since the Bank of Japan (BoJ) opted for more flexibility. The central bank made changes in its complex seven-year-old yield-curve-control (YCC) policy last week, as per which yields on the 10-year Japanese government bond (JGB) can rise as much as 1%, instead of being capped at 0.5%. After the announcement, the 10-year JGB yields rose to a 9-year high and touched 0.607%.
Rise in demand for Japan Bonds
Experts believe that this announcement will release all the suppressed demand for Japan bonds. Most of the demand is likely to come from banks, insurance companies, and pension funds who believe that the slightly higher yields and reduced involvement of the BoJ would lead to increased liquidity and returns. In 2022, Japan bonds witnessed the longest trading drought since 1999 when the 10-year JGB failed to trade for three consecutive days due to BoJ’s tight yield curve control.
Ales Koutny, head of international rates at Vanguard Asset Management told Reuters, “The initial target for investors seems at least 0.70% to 0.80% so we continue to expect a grind higher in yields and are positioned for such…that’s the kind of level we heard over and over again from local investors. It also starts looking interesting on a risk-reward for currency-hedged investors.”
With rising yields and lower exchange rate risk, domestic investors are likely to turn to Japanese government bonds instead of overseas assets. Hence, there is widespread speculation that there will be a “homecoming” and it would also lead to pressure on global interest rates. The BoJ’s latest stance has already got leading central banks around the world worried. The European Central Bank (ECB) in its Financial Stability Review in May 2023 had already mentioned that policy normalisation in Japan could have a major impact on the global bond markets. The attractiveness of European and US bonds would decline and there would be repatriation of funds to Japan.
How to invest in Japan government bonds
Given this background, investing in Japanese government bonds can offer investors a useful portfolio diversification. The easiest way for international investors to get exposure to JGBs are Exchange Traded Funds (ETFs). Mentioned below are three such Japan Government Bond ETFs that offer a low cost easy way to diversify a portfolio.
Xtrackers Japan Government Bond UCITS ETF 1C
Founded in November 2013, this index fund by Xtrackers aims to reflect the performance of the JPY-denominated bonds issued by the Japanese government. It is managed by DWS, and it tracks the FTSE Japanese Government Bond Index.
The Xtrackers Japan Government Bond ETF also offers exposure across the whole yield curve (minimum time to maturity of 1 year). 26.9% of the holdings are in binds with a maturity of 15-25 years, while 15.49% of the holdings are in bonds with a maturity of more than 25 years. It holds a total of 261 securities and the top three holdings are Japan-37 (30-year issue) 9/42, Japan-37 (30-year issue) 9/42, and Japan -35 (30 year issue) 09/41.
The ETF has a total asset base of $339.3 mn and an all-inclusive fee of 0.15%. The yearly rate of return on this fund is -16.67%. The volatility for 1 year for this ETF is 11.82%.*
Vanguard Japan Government Bond Index Fund
The Vanguard Japan Government Bond Index Fund was launched in 2014 and employs a passive management or indexing approach which aims to track the performance of the Bloomberg Japan Government Float Adjusted Bond Index.
The Index includes investment-grade Japanese yen-denominated treasury and Japanese government-related bonds with maturities over one year. The investment-grade bonds have a relatively low risk of default.
The Vanguard ETF has a total asset base of $260.28 mn. It holds a total of 338 bonds and the total fee of the fund is 0.12%. The fund offered an annual return of -5.66% in 2022. 27% of the investments are in bonds with a maturity of 1-5 years while 19.4% of the investments are in bonds with a maturity of 5-10 years.**
iShares Core Japan Government Bond ETF
Launched in 2020, the iShares Core Japan Government Bond ETF tracks the investment results of the FTSE Japanese Government Bond Index. The ETF is managed by BlackRock Japan and it offers exposure to a broad range of fixed-rate, local-currency Japanese government bonds.
It offers an average annual return of 2.83%**, while its current management fee is 0.06%. There are a total of 263 bonds and total net assets of $24.2 bn. The top three holdings of the ETF are Japan-37 (30-year issue), Japan 370 (10-year issue), and Japan 34 (30-year issue).*
*as of August 7, 2023
** as of July 31, 2023
