It might be considered absurd, if not for the unprecedented contortions in global financial markets.
Pacific Investment Management Co.’s largest international bond fund and China are piling into negative-yielding Japanese debt, buying securities that pay out less than the purchase price. And there’s a way to turn a tidy profit off the trade.
At the heart of the strategy is the world’s insatiable appetite for dollar assets, which is presenting an opportunity for investors with greenbacks to spare: the chance to pick up extra yield, a luxury in an era of record-low interest rates. For dollar lenders, even three-month Japanese bills, trading at a rate of negative 0.24 percent, offer juicy returns through a swap transaction that locks in exchange rates.
Pimco, which manages $1.51 trillion, is one dollar-rich investor looking to tap into the phenomenon. Its Foreign Bond Fund, which protects against currency swings, added short-dated Japanese government debt this year, data compiled by Bloomberg show. The trade was yielding almost 1.3 percent as of Aug. 19. China’s been another big buyer, accumulating a record amount of bills last quarter, Japanese Ministry of Finance data show.
“We can in some markets buy even negative-yielding assets and hedge them into U.S. dollars to create attractive positive yields,” said Sachin Gupta, who runs the $7.8 billion Pimco fund from Newport Beach, California. Short-dated Japanese debt “is as close to a risk-free instrument as is possible” in the country, and, when held to maturity, the profit is locked in from the start, he said.
The trade shows how negative interest-rate policies outside the U.S. are turning the world’s bond markets upside down by stoking demand for dollar-denominated securities and complicating longstanding investment strategies. The flip side of the opportunity is that global investors fleeing $9 trillion of below-zero sovereign yields need to pay up to protect against currency risk when buying American debt. For Japanese and euro-based asset managers, 10-year Treasuries yield practically nothing after factoring in hedging costs.
The upshot is that those with dollars to lend are the belles of the bond-market ball, and that’s where China may come into play.
For more on the global dollar crunch, click here.
The People’s Bank of China holds $3.2 trillion of currency reserves, the world’s largest hoard, and about 60 percent of that is in dollars. That makes the central bank a strong candidate to enter into this kind of trade.