High-yield and US debt at risk if Japan repatriates

High-yield bonds and US Treasuries top the list of vulnerable assets should the triple disaster of earthquake, tsunami and nuclear breakdown prompt Japanese investors to bring overseas funds back home.

Such moves -- which may already be under way, given some of the currency movements of the past few days -- are also likely to sour global merger and acquisition and outward direct investment activity from Japan, one of the top 10 players.

The stakes are significant for world financial markets if Japanese investors bring money home to fund reconstruction, which is expected to cost around $180 billion, or around 3 percent of its gross domestic product.

"One of the issues when the immediate problem dies down is bringing the funds back home," said Ian Bright, senior economist at ING. "Japanese investment is widespread all over the world."

Japan holds nearly USD 7 trillion of external assets. Excluding the more than USD 1 trillion of this that is in foreign reserves, around USD 2.6 trillion is held in foreign bonds and money markets and another USD 680 billion in overseas equities.

US Treasuries are, of course, a major pull, with Japan as a whole investing around USD 890 billion in them.

The Bank for International Settlements also estimates that Japanese banks hold around USD 745 billion in cash and fixed income in non-emerging Europe.

One of the first areas which may come under pressure, beyond the well-known US Treasury holdings, is high-yielding foreign currency bonds, known as Uridashi, which are very popular among Japanese households, particularly in South Africa and Brazil.

Japanese investment in Brazilian debt rose by 84% in 2009, the most recent year for which data is available, to around USD 17 billion, according to the Bank of Japan.

Thomson Reuters data shows Japan-based funds hold USD 197 billion in foreign bonds, with the United States, Australia and Brazil comprising the largest source of issuance.

HSBC's data show the total issuance of Uridashi bonds totalled USD 4.6 billion so far this year, 43% of which was issued in Australian dollars. Of USD 14.1 billion of Uridashis issued last year, Aussie bonds totalled USD 6.6 billion and Brazilian real bonds in USD 2.4 billion.

"From a repatriation flow perspective, the flow could be most dramatic for the Australian dollar and Brazilian real," HSBC said in a note to clients.

Bringing it home?

The yen is the primary signal that some repatriation, or at least an expectation of it, is already underway.

Since Thursday, just before the quake, the yen has risen 3% against the Brazilian real and more than 4% versus the Australian and New Zealand dollars.

The biggest loser was the South African rand, which lost more than 5 percent.

After the Kobe earthquake in 1995, the yen rose more than 20% to a then post-war high around 79.80 per dollar in a space of around three months, although appreciation was also driven by speculation about Federal Reserve policy easing.

Some of what is under threat is seen in the latest Reuters poll of 13 Japanese fund managers conducted in February.

It showed investors holding 59% of their equity assets in North America and Europe and the same in their bond portfolios.

Finance Ministry data for 2010 showed Japanese investors bought a net 25.8 trillion yen (USD 316 billion) of foreign stocks, bonds and money instruments, with 69% allocated in the United States. Australia grabbed 6 percent of the pie.

In January, the Japanese government bought just over 1 billion euros of bonds issued by the European Financial Stability Facility.

Corporate finance activity

Japan's influence on world finances is not, of course, limited to asset holdings. It is also a big driver in foreign direct investment and well as overseas mergers and acquisitions -- some of which may be scaled back in the medium term.

The Organisation for Economic Co-operation and Development estimates that Japan has been among the top 10 sources of international M&A over the past five years.

It accounted for USD 28 billion of the global USD 680 billion in 2010 and around USD 32 billion of USD 580 billion in 2009.

UNCTAD, the UN trade and development agency, meanwhile, says that outward Japanese foreign direct investment -- including M&A -- amounted to USD 74.7 billion in 2009.

It is by no means certain, however, that Japanese investors will liquidate their overseas assets first if they needed cash.

They own plenty of Japanese government bonds -- 95% held domestically -- and it's easy to find sellers: The BOJ has just pledged to buy 10 trillion yen of bonds, mainly JGBs.

"You have to figure that that will be the first place they would go," said Jeremy Armitage, global head of research at State Street Global Markets.