Investing in Japan has been very lucrative this year. 'Abenomics' – a reformative initiative introduced by the Prime Minister Shinzo Abe early this year is largely the reason for this boost in optimism.
The Bank of Japan follows a policy to increase Japan’s monetary base at an annual run of about 60–70 trillion yen. This injection of liquidity will continue until the inflation target reaches 2%.
This bond buying kept a lid on Japan Government bonds rates for the near term, but according to BOJ Governor Kuroda, interest rates will likely take an upturn once BOJ attains 2% inflation target and stops buying bonds.
The inflation rate in Japan was recorded at 1.10% in October 2013 which showed a steady improvement since May when it recorded a deflationary rate of 0.3%. Amid such a backdrop, WisdomTree has brought a new Japan-based investment option – WisdomTree Japan Interest Rate Strategy Fund JGBB – to benefit from potential interest rate changes in Japan and a weakening of yen.
JGBB in Focus
This newly launched fund looks to track the WisdomTree Japan Interest Rate Strategy Index. The Index consists of long positions in the U.S. treasury bills having a remaining maturity of greater than one month and less than three months and short positions in JGB (maturing 5 to 10 years) futures contracts thus providing exposure to changes in Japanese interest rates (read: 3 Covered Call ETFs to Pump Up Your Income).
As far as asset allocation goes, the fund has 76.58% exposure in Japanese rates and 23.42% Japanese currency contracts. US treasuries get 99.05% asset allocation. The fund charges 50 bps in annual fees.
How Does it Fit in the Portfolio?
As far as short-term bonds are concerned, these offer less vulnerability to interest rate fluctuations. As of December 20, 1-month treasury yield was 0.02% while the 3-month treasury yield was at 0.07%. These rates were unchanged from before the beginning of the taper talk (read: 3 Income ETFs to Watch Ahead of Key Fed Meeting).
Thus, the fund completely rules out the rising rate concerns through its extremely short duration. Also, the Fed has promised to keep the key interest rate low for longer, thus giving another round of assurance to short-term Treasury bond holders.
Coming to the fund’s JGB exposure, a rise in inflation might stimulate the Japanese economy which in turn might push up the longer-term Japanese interest rates leading to slump in bond returns.
Japanese inflation expectations are presently averaging 1.5% per year while bond yields are hovering around the all-time low. Hence, inflation-adjusted real yields have entered the negative territory. Quite expectedly, bondholders will eventually demand higher yields which in turn put pressure on bond prices. Thus, a bearish stance in Japanese interest rates will likely cushion investors from bond price losses.
The third agenda is the declining Yen. With the Fed taper already taking place and the BOJ’s stimulus still in place, Yen will likely lose more strength relative to the greenback in the coming days.
JGBB really does not face any competition. While there are plenty of funds in the long-short space including ProShares Credit Suisse 130/30 (CSM) and PowerShares S&P 500 BuyWrite Portfolio (PBP), these don’t offer Japanese exposure.
Thus, we expect JGBB to have a clear road ahead. The fact can also be validated by its AUM number. Within just two days of the launch the fund accumulated $5 million in assets suggesting that there might be some interest in this product by Japan-focused investors.
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- interest rates