The quest for yield

  • 02 Jun 2006
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In a land of negligible risk-free returns, Japanese banks are enjoying surging demand from financial institutions seeking structured deposits and other structured investments, such as CPPI. EuroWeek asked Shinsei Bank's experts to explain some key trends and developments.

It was back in 2001 when the Bank of Japan turned to zero interest rates to help reflate the economy and help the bank sector purge itself of its bad loan problems.

Since then, yields on almost every kind of investment, from risk-free Japan Government Bonds to lower rated corporate bonds, have shrunk sharply. Although JGB yields are rising as confidence in the economic recovery grows, the Bank of Japan maintains its zero interest rate policy.

Even lowly triple-B rated straight bonds issued by a mid-market Japanese company traded at a miserly 25bp over JGBs at five years in early April, giving a total yield of about 1.68% per annum.

Meanwhile, Japan is getting richer, from corporation to individual, megabank to small regional lender. But most of this money is inert, trapped in low, or often no, yield deposits or other passive investments.

Deep liquidity, rising confidence

"Household savings in Japan amount to around $14tr at the moment," says Stuart Baker, general manager running fixed income in the capital markets group at Shinsei Bank in Tokyo. "The trend throughout the country in recent years — for investors from large institutions to local individuals — has been to become bolder in investment decisions at home and abroad."

Shinsei Bank has been exploiting this trend by offering regional banks and other smaller financial institutions a wider range of structured deposit products. "This market has been enjoying staggering growth in recent times and all the leading Japanese banks have been placing considerable emphasis on structured deposits for their clients," adds Baker.

Shinsei, for example, introduced variable maturity deposits for customers in the spring of 2004, attracting about ¥500bn in the first year. The balance swelled to slightly over ¥900bn as of March 31 this year. Aozora Bank began to offer a similar type of product in June 2005, providing the most obvious competition to Shinsei.

Shinsei is also adapting the product to reflect the potential for rising interest rates, by offering shorter dated variable maturity deposits. With the prospect of the Bank of Japan ending quantitative easing, Shinsei has introduced products that minimise potential opportunity loss for depositors should rates rise quickly.

CPPI arrives in Japan

One of the latest structured investment products on offer in Japan is constant proportion portfolio insurance, or CPPI.

CPPI, in simple terms, is a structured product based upon the dynamic allocation of a basket of  risky assets and risk-free assets, to obtain the appropriate mix of principal protection and a variable upside potential, depending on the performance of the risky assets.

Risk-free assets safeguard the investor's principal while that investor may also, but not necessarily, benefit from upside on the premium assets if the underlying risk assets perform well.

"With interest rates on deposits virtually zero in Japan, almost all investors are looking for ways to enhance returns on their cash while also protecting their capital," explains Baker. "CPPI is an ideal tool to protect investors' capital, while at the same time allowing investors sufficient exposure to alpha generating premium assets. Although it has been around a long time, CPPI is relatively new to Japan and very new to the regional financial institutions."

The average size of most such investments in Japan is about ¥1bn.

The investor in CPPI products theoretically has zero principal risk but captures the upside of a selected index or basket of indices. The indices are mainly hedge fund indices that relate to tradable assets and derivatives in the global financial markets.

Safety, with upside

Richard Liang, general manager in charge of the structured credit and alternative investment division at Shinsei, explains: "We have the experience, expertise and relationships to be able to select out the benchmark indices for those of our clients that do not have the critical mass or staff able to contemplate creating such structured investments themselves."

Shinsei manages the investments in order to be able to return the principal at maturity, as well as the incremental returns.

For example, the bank could invest the bulk of a five to 10 year yen deposit, for example, in risk-free paper, while the balance, perhaps initially 40%-60% of the face amount, might go into the selected indices.

Non-discretionary expertise

But, while Shinsei does need to apply its expertise to manage the exposures, the client knows what it is letting itself in for. "There is no discretion on our part," explains Liang. "The client knows in advance by agreement how we are going to allocate the capital and that allocation is based on our advice and their appetite for risk."

One product Shinsei has been offering is the principal protected hedge fund index performance-linked deposit.

This is a principal protected investment in a US dollar (or other currency, agreed with the depositor) deposit, which pays a hedge fund performance-linked bonus interest rate by participating in an upside of a hedge fund investment reference portfolio.

The reference portfolio dynamically rebalances between risky and risk-free assets based on predetermined algorithms until maturity. In this instance, the reference portfolio is linked to HFRX, the leading global hedge fund index compiling over 70 funds categorised into nine different strategies.

"Back-testing," says Liang, "shows a five year US dollar CPPI investment linked to HFRX returning between 6% to 11 % per annum, depending on the timing of the investment."

The size of the structured investment product market is difficult to determine, but Shinsei's bankers says that they are one of the biggest players and aim to consolidate and expand on that position. 

  • 02 Jun 2006

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Citi 417,761.51 1606 9.02%
2 JPMorgan 380,362.89 1737 8.21%
3 Bank of America Merrill Lynch 364,928.71 1322 7.88%
4 Goldman Sachs 269,252.76 932 5.82%
5 Barclays 267,252.43 1082 5.77%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 HSBC 45,449.36 196 6.56%
2 BNP Paribas 38,734.80 217 5.59%
3 Deutsche Bank 37,615.10 139 5.43%
4 JPMorgan 34,724.19 118 5.01%
5 Bank of America Merrill Lynch 33,835.53 112 4.88%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 JPMorgan 22,475.46 105 8.65%
2 Morgan Stanley 19,057.00 101 7.34%
3 Citi 17,812.08 111 6.86%
4 UBS 17,693.89 71 6.81%
5 Goldman Sachs 17,333.10 99 6.67%