Trend-following investors switched bets after price crossed key threshold
Laurence Fletcher and Tommy Stubbington in London and Leo Lewis in Tokyo
Massive holdings of Japanese government bonds at the country’s central bank mean that the market rarely budges © Bloomberg
Hedge funds are taking the blame for a drop in Japanese government bond prices that has reverberated around global debt markets.
Benchmark bonds in the US, Germany and the UK have all taken a tumble in recent weeks, driven by an unusual outbreak of optimism about the global economic outlook that has boosted equities.
But sharp price falls in the typically tranquil Japanese government bond market have stood out — and some analysts say they bear the fingerprints of trend-seeking computerised hedge funds scrambling to cover losses.
The suspicions are rekindling a debate about the influence of these hedge funds, which have frequently been blamed when markets swing to extremes without clear fundamental triggers.
“Futures-driven selling has been the main cause of the [Japanese market] move,” said Peter Chatwell, head of rates strategy at Japan’s Mizuho International. “It looks like an unwind of leveraged long positions.”
Massive holdings of JGBs at the country’s central bank mean the market rarely budges, but the 10-year benchmark yield leapt this week to a high of minus 0.02 per cent, from minus 0.19 per cent at the start of November — a large move by Japanese standards that reflects falling prices.
The yield slipped back to minus 0.09 per cent on Thursday.
Certain types of hedge funds that try to latch on to trends in global markets — known in the industry as commodities trading advisers, or CTAs — had been betting successfully on rising JGB prices since around this time last year, according to Société Générale’s Trend Indicator.
But their investments turned sour as the market went into reverse in early September, leaving them nursing losses. The Trend Indicator has, as of late last week, shifted to betting on falling prices.
The global pullback in fixed income since mid-September has been sparked by easing trade tensions and a sense that the gloom about the prospects for the world economy was overdone.
Selling in JGBs — which also reflects receding expectations that the Bank of Japan is on the brink of cutting interest rates — has been a catalyst for broader moves at crucial points during the sell-off, including over the past week, according to Jim McCormick, global head of desk strategy at NatWest Markets.
“CTAs have built in some cases record long positions in core fixed income markets,” Mr McCormick said. “With momentum signals now turning less bullish, positions could be set to follow.”
Bond traders and analysts in Tokyo point out that trend-following hedge funds had built huge net long exposure to Japanese bonds by the end of August. Those positions, said analysts at Nomura, were highly leveraged and prone to sharper moves in the weeks and months that followed.
Some analysts calculate that the key point for many of those funds in 10-year yields was minus 0.11 per cent. Once the yields popped above that level in November, many funds that had bought the bonds in the August rush were left holding losses, turning them into automatic sellers.
Critics say these funds, which run about $300bn in assets, push markets further than they otherwise would have moved, damaging other market participants. But many managers of trend-following funds say the amount they trade is only a fraction of total market volume and their footprint is small.
And while these managers have sold Japanese government bonds, the extent to which they are now betting on falling prices varies. The bonds are “not a big short”, said an executive at one hedge fund.
Rotterdam-based hedge fund Transtrend, which manages $5.4bn in assets, owned Japanese government bonds for most of this year, making money in the process, but started cutting this position late last month. Rather than betting on falling prices, the fund now has no exposure.
“We do not believe that Transtrend has played a significant role in exacerbating the safe haven or JGB trend,” said executive director André Honig. “For the CTA sector as a whole, it shouldn’t be the case either.”
CTAs employ teams of PhD scientists to design algorithms to spot and profit from market trends, and they have been enthusiastic buyers of bonds on very low or negative yields in recent years.
While many human hedge fund traders and other investors have recoiled at the prospect of effectively paying for the privilege of lending money to a government, quants, which feel no fear, kept holding on as the trend took yields into the deep freeze.
That has been a big driver of gains at trend-following funds this year. Such funds are on average up 6.2 per cent this year to the end of October, according to data group HFR, despite suffering some losses in recent months as bonds weakened.
London-based Aspect Capital has gained 18.5 per cent this year in its main fund. It has been betting on rising bond prices, according to an investor letter seen by the Financial Times, and suffered a loss on its bond position in early November. The letter did not detail which countries’ bonds Aspect owned. Aspect declined to comment.
Mr Chatwell said the swings in the market had undermined bond-buying strategies in recent weeks. He said: “While there’s all this volatility it’s harder to generate income from the JGB market. A lot of investors are sitting on the sidelines and waiting for a better entry point.”
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