Japan’s stock market and currency tend to move in opposite directions and this negative correlation has been especially apparent this year: Japanese equities have shot up while the yen has plummeted against all other major currencies.
This leaves international investors with a dilemma: should they hedge their currency exposure when investing in Japanese equities, or would they risk missing out if the yen turns a corner?
Ruffer’s investment director Steve Russell said the firm has taken a bold bet on the yen rising. It holds 20% of its portfolio in the Japanese currency across cash, short-dated Japanese government bonds and yen call options against sterling and the US dollar. The firm also holds Japanese interest rate options, positioned to make money as Japanese rates rise.
Back in 2007 and 2008, Ruffer took on yen exposure by owning Japanese equities, which fell in valuation a little, but the yen upside more than compensated.
But Russell said that this year he felt it would be too risky to own Japanese equities. “We’ve held [yen] in a more painful way – straight Japanese cash and short-dated government bonds,” he said.
While not everyone is as confident as Ruffer, other managers are placing smaller bets on the yen. JPMorgan Asset Management is running a small overweight as a hedge against a broader decline in risk markets while Jim Leaviss, chief investment officer of fixed income at M&G Investments, also believes there is value in the yen.
“We like the yen from its Big Mac index valuation methodology,” he said, which is a comparison of how much the popular burger from McDonalds costs in different countries. Looking at purchasing power parity, he believes the yen is 15% undervalued, although it could be even wider.
Russell cited three triggers that could prompt the yen to strengthen: if the difference narrows between US and Japanese central bank rates; if inflation puts pressure on the Bank of Japan to relinquish its tight control over rates; and if the carry trade unwinds.
On the latter, Japan remains the only developed market economy with zero rates, so investors have been borrowing in the yen to invest in higher risk assets such as US tech stocks.
That trade has been profitable recently because the yen keeps falling. However, if the yen starts to appreciate, this carry trade would become unprofitable and would need to be unwound quickly.
The most likely catalyst of these would be “if the relentless march upwards of US yields stops or goes into reverse at the same time as Japan raises rates,” Russell said.
Even if investors do not want to take such an aggressive stance to buy the yen because they think it will appreciate, there are benefits to owning it – particularly if they are positive on the future of Japanese equities.
Dean Cook, a multi-asset fund manager at Aviva Investors, said he was concerned about the risk of a sharp repricing in the yen so he took on some currency exposure to pair with his overweight position in Japanese equities as a way to manage the risk of the trade.
Similarly, Oliver Blackbourn, a multi-asset portfolio manager at Janus Henderson, has a neutral exposure to Japanese equities (whereas he is negative on most other equity markets), but is also using the yen to counterbalance his equity exposure.