Foreign Investors Not Responsible for Nikkei Decline

The Nikkei fell about 6.5% last week. There was speculation that foreign investors, who had bought tens of billions of dollar worth of Japanese shares since Abe was elected prime minister, had begun taking profits. 

Yet the weekly Ministry of Finance data shows foreign investors were net buyers of (JPY113.6 bln or ~$1.1 bln)Japanese shares in the week ending June 7. This is roughly half of the amount sold in prior two weeks (JPY269 bln). In May as a whole, the weekly MOF data shows foreign investors bought about $13.6 bln of Japanese shares.

This dovetails with Blackrock's estimate all of Japanese equity ETFs that trade in the US took in around $10 bln in May, which was a record according to its data. Last week, while the MOF says were net buyers of shares, the two leading Japanese equity ETFs in the US, the MSCI Japan Index (EWJ) and WisdomTree's Japan Hedged Equity Fund (DXJ)saw capital outflows for the first time in months. Yet, is was barely a trickle.

EWJ is the bigger of the two with about $11 bln AUM. It saw experienced a weekly outflow of about $340 mln. It was the first liquidation since February. DXJ has about $9 bln AUM and experienced a $145 mln outflow, for the first time since late 2012. Some anecdotal evidence suggest EWJ may be experiencing some inflows in recent days, while DXJ may still be seeing some redemptions. Perhaps the increased volatility (and strengthening of the yen) deterred demand for a currency hedged vehicle.

The fact that a 20% decline in the Nikkei has not spurred greater foreign liquidation may be an important signal.  It suggests that despite the volatility and the challenge of implementing the aggressive monetary policy, many investors believe there has been a regime change of consequence in Japan.  

A corner, if you will, has been turned.  For many years, investors had kept Japanese equity exposure below benchmarks, which generally made sense given its under-performance.  Investors cannot afford to do so any more.  

Japanese investors, for their part, continue to be net sellers of foreign bonds.  They had stepped up their selling in the last two weeks of May, divesting some JPY2.3 trillion of foreign bonds.  These two weeks were really an anomaly.   In the week ending June 7, they sold almost JPY387 bln.  This is essentially the average pace of sales for the last 20 weeks.   Japanese investors also sold JPY222 bln of foreign equities.  This is slightly above the average pace over the past 20 weeks.  

The persistent net sales of foreign assets is also an important signal.  Many observers shake their heads in disbelief.  Why would Japanese investors repatriate funds in the wake of the government and central bank's stepped up efforts that debase the currency, the critics ask.  

Japanese investors have accumulated trillions of dollars of foreign assets.   The historic appreciating trend of the yen undermined their value.  The rapid depreciation of the yen allows Japanese investors to repatriate some of their overseas largess on favorable terms, especially given the rally in stocks and bonds in over the last few years.  Abenomics is giving Japanese investors an opportunity replenish their domestic savings that have been drawn down.  

It is important to reiterate that there does not seem to be a good correlation between portfolio flows and the direction of the dollar-yen.  Partly this maybe that short-term speculators are more often than not the marginal buyers or seller of yen.  Currency hedging of bonds and stocks may also dilute the impact of portfolio flows.   

Some institutional investors may hedge the currency on a quarterly basis using a forward contract or a swap agreement.  The Nikkei is up about 4% thus far this quarter.  They are still properly hedged.  However, some investors have more dynamic hedges, adjusted more frequently.  Consider the investor who hedges on a monthly basis.  The Nikkei is off almost 7% so far this month.  That means that she may be over-hedged, which implies a need to buy yen (to reduce the short yen hedge to the Nikkei).  Given price developments in the JGB market, the quarterly hedgers may have a more significant mismatch to contend with than the shorter-term hedgers.