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Abenomics" is a term coined by investors to refer to a set of policies put in place by Japanese Prime Minister Shinzo Abe to get Japan out of the deflationary funk it has been in for the last decade. In order to achieve the target of two per cent inflation, he has forced the Bank of Japan to adopt a very aggressive monetary policy stance - effectively doubling the monetary base - and agree to rapidly scale up its balance sheet towards this inflation objective. This is a fundamentally more aggressive posture to end deflation than the Bank of Japan has adopted in the past. Just as "don't fight the Fed" has been a winning trade over the last few years, investors now seem to be clear that one should not fight the Bank of Japan and Abenomics either.
The Bank of Japan is seemingly openly signalling that it will drive the yen into the ground to push up exports, create inflation and improve the profitability of corporate Japan. It has the tools and willingness to force the currency lower. The yen has already moved to a new level of 95-97 (dollar/yen), from levels of 80-82 before Mr Abe's appointment as prime minister. Many of the Japan bulls have pencilled in the yen crossing 105-110 within 12 months. Such a sharp depreciation has fundamentally altered the profitability of most of corporate Japan and put other countries such as South Korea under tremendous pressure.
Many macro observers now seem to believe that this time the change is for real and that this is the last chance for the country to get its act together. There is a clear desire on the part of the populace for Japan to grow and regain relevance. The Japanese markets have been on fire; betting on Japan has been the single biggest macro trade over the last six months. Investors have been falling over themselves to cover their Japanese underweight, a trade that has consistently been in the money for over a decade now. People forget that at its peak in 1989, the market capitalisation of Japan was greater than the Wall Street's. If investors were to fully cover their long-standing underweight and go overweight, the flows of capital involved would be very dramatic.
If successfully implemented, by lowering domestic yields, causing higher inflation (negative real yields) and weakening the yen, Abenomics should boost the appetite for overseas assets among Japanese investors. Ultimately, if they can only get negative real yields at home, they will have to move elsewhere to protect capital in real terms. If one considers the experience of 2004-07, this move to overseas assets should favour emerging market asset valuations.
Will Abenomics drive emerging market asset prices higher and prove to be a new boon to the emerging market asset class? Given how poorly emerging markets have done over the last 12 months, and the low level of enthusiasm towards the asset class currently, some market players are wondering whether Japanese flows could be the new saviour for emerging market asset prices.
In order to understand this possible trend and its impact, we have to first try to quantify just how significant these flows could be. The pool of assets managed by Japan's real money investors (mutual funds, life insurance and pension funds) is estimated to be about $8 trillion (source:UBS). Of this $8 trillion, about 20 per cent is currently invested abroad. Given the size of the money being managed, it would be tempting to get bullish on emerging markets based on potential Japanese flows alone, as even a one per cent swing in asset allocation towards emerging markets would move about $80 billion (or about 30 per cent of the total portfolio flows that emerging markets attract in a year).
However, before getting carried away by the sheer size of the numbers, one should be aware that overseas flows from Japanese investors have traditionally been skewed towards the more liquid and mature developed-country financial markets. Emerging markets accounted for less than five per cent of Japan's total stock of overseas investment in 2011, according to UBS. While this ratio has risen since 2003, when it was less than two per cent, it has stagnated at five per cent since 2007. Just to give some context, since 2005, Japanese institutions have invested $73 billion in emerging market stocks and bonds and have put in over $850 billion into G10 financial assets. Over the last 12 months, emerging market assets have attracted $7 billion versus $50 billion just into France, as reported by UBS.
Japanese flows in the recent past have not been large in relation to total portfolio inflows into emerging markets. Also, to the extent these flows matter at all, they are more in the emerging market debt markets than in equities. Japanese flows into the Philippines, Indonesia, Mexico and South Africa have at various points of time been in excess of 10 per cent of incremental debt inflows. In none of the major emerging market equity markets have Japanese inflows been a significant factor.
Given this pattern, expecting a sudden surge in flows into the emerging market asset class from Japanese investors seems unlikely. Given their risk profile, required rate of return and willingness to tolerate volatility, the more advanced financial markets will be bigger beneficiaries. A valid point of view is that while Japanese institutions may move overseas for yield, given how well the Nikkei is performing, why will they move into equities outside their home country? If Japan is truly back, it is unlikely that any other large liquid equity market will have much greater upside than the Nikkei itself.
It does not look like Mrs Watanabe will be the marginal buyer for the emerging market asset class as some of the bulls would have us believe.
The emerging market asset class - especially equities - is going through its own travails at the moment. Investors are questioning the whole BRICS concept and its investment attractiveness. The growth premium of emerging markets over developed markets is under pressure, with the external balance sheets of most of the former category of economies deteriorating. The end of the commodity super cycle and the linked structural slowing of China has also impaired the growth prospects of many of the larger emerging market economies. As the emerging market asset class works its way through its challenges, it is unlikely that Japanese capital inflows will be a saviour for these markets. The debt markets of both the US and the European Union will be much bigger beneficiaries.
The writer is fund manager and CEO of Amansa Capital
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
