Debt denominated in emerging market currencies accounted for the majority of issuance of so-called Uridashi bonds for the first time in the first three months of 2017.
The development is a further sign of a surge in demand for emerging market assets, with cross-border portfolio flows hitting a 26-month high of $29.8bn in March, according to the Institute of International Finance, an industry association, the fourth straight month of net inflows.
A record 53 per cent of Uridashi — bonds issued outside Japan but aimed at Japanese retail investors, who are often known collectively as “Mrs Watanabe” — were denominated in EM currencies in the first quarter of the year, stripping out those based in yen, according to figures from Bloomberg and Brown Brothers Harriman.
The move caps a dramatic rise for EM bonds, which rose from nothing in the early 2000s to account for 49 per cent of Uridashi issuance in 2012, before retreating once again as the appetite for EM assets waned in the wake of the so-called “taper tantrum” of 2013, as the first chart shows.
Their renewed resurgence is indicative of an increasingly desperate global hunt for yield, with investors searching further afield for returns amid record-low interest rates across much of the developed world.
“Uridashi bonds represent a small slice of the FX market, but we believe that the observed trends in this segment can reflect those of the larger Japan investment community as well,” said Win Thin, global head of emerging market currency strategy at Brown Brothers Harriman.
Total Uridashi issuance last year was $27.3bn, of which $12.9bn was denominated in foreign currencies in both developed and emerging markets. Non-yen issuance fell from a peak of $20.4bn in 2010 but was above the $9.9bn of 2015. The first three months of 2017 saw non-yen issuance of $2.5bn.
Mr Thin said the rising share of EM issuance was reflective of Japanese investors becoming more comfortable with investing in emerging markets, as memories fade of the sharp declines in currencies such as the Brazilian real, South African rand and Russian rouble in 2013-15, which hurt Uridashi investors, who are typically unhedged.
“The extreme declines scared people. If you are getting 6-7 per cent [yield] you could be wiped out in a matter of days,” said Mr Thin.
He saw the trend continuing amid near-zero interest rates in much of the developed world, relatively high rates in emerging markets and “a wider appreciation for EMs in general”, although any intensification of the pace of monetary tightening by the US Federal Reserve could cause some disruption.
Demand for EM bonds has been led by a jump in issuance of paper denominated in Russian roubles and Indian rupees.
Until 2015, rupee issuance was minimal, but it has surged since then to reach $1.2bn in 2016 and a record 22 per cent of EM issuance so far this year, as the second chart shows.
“India is a pretty safe and stable story. We are definitely picking up a lot of interest this year,” said Kevin Daly, emerging market fund manager at Aberdeen Asset Management, which operates an Indian bond fund.
Investors in rupee-denominated Uridashi bonds “are not going to get double-digit returns” as the Indian central bank will be likely to resist any significant strengthening of the currency, something that would lead to windfall gains, Mr Daly said. But a yield of 5-7 per cent and potentially a little currency appreciation are possible, and “you can’t complain about that”, he added.
The rouble has jumped to 24 per cent of EM issuance this year, from 6 per cent in 2016 and an average of 2 per cent in the past decade, as the Russian currency has stabilised after its dramatic slide between 2014 and early 2016. Although interest rates have been cut four times in the past 12 months, they are still a chunky 9.25 per cent.
The Mexican peso has also doubled its share of EM issuance from 5 per cent last year to 11 per cent so far this year, helped by a doubling of benchmark interest rates to 6.5 per cent in the past 12 months.
“Foreign ownership [of Mexican bonds] has increased significantly since the [US presidential] election. Part of that is from Japan,” Mr Daly said.
Mr Thin added: “The fundamentals remain solid, and the peso has finally found some traction as Banco de Mexico’s tightening cycle continues even as the Trump administration appears to be softening its stance towards Mexico.”
The Brazilian real, long a mainstay of Uridashi issuance, has seen its share fall, something Mr Thin attributed to the country’s “accelerating” monetary easing cycle, which has seen rates cut by three percentage points to 11.25 per cent since October.
However, issuance in South African rand, another one-time favourite, has dwindled with Mr Thin arguing that “heightened political and downgrade risks lie ahead and these go hand in hand with a poor fundamental outlook”.
The rise in the proportion of Uridashi issued in emerging market currencies has gone hand in hand with a slump in issuance in Australian and New Zealand dollars, which accounted for a combined two-thirds of non-yen bonds between 2004 and 2008, but just 10.8 per cent so far this year.
Interest rates have fallen sharply to record lows in both countries, of 1.75 per cent in New Zealand and 1.5 per cent in Australia.