A short note on another recent client question, mainly looking at fixed income exposures.

A very good observation is the low headline yields on offer in Japan, which can make for a difficult conversation with clients, who wonder (quite reasonably!) why we might be interested in an allocation (within the broader passive vanguard international fixed income product) to Japan, which has quite a large weight within the overall country/geographic allocation. After all, headline yields over there are scarcely above 30 basis points.

The answer is mainly because the yen is expected to rise, by a lot, over the next 10 years. Most notably that’s true against the USD (where the broad real effective exchange rate is at multi-decade highs) but it is also the case for the hedged Australian investor, where the yield pick up is quite sizeable.

The below shows the forward points added to 10yr JGB’s, against the Aussie 10yr (titled GACGB10) and another slightly fancier version of calculating the hedge.

For the most part, investors attempt to equalise real returns, across countries. Now sometimes the cross currency basis (the amount left over relative to the zero that is expected, from IRD’s relative to FX forwards) can move in ways that are difficult to predict, or understand, which is why we don’t try to do this ourselves, and are quite happy to let the product (here the vanguard) take care of all that for us.

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