Households’ financial surpluses sharply increased in 2020 and remained high in 2021 due to the COVID pandemic (Exhibit 1). Most of the surplus continued to go to cash and deposits, but there was a notable increase in funds going to investment trusts (with a large portion invested in foreign equities) in 2021.
Exhibit 1: Households notably increased investment in foreign securities through investment trusts
Amid rising international yield differentials and a weakening yen, there is market chatter about whether this is the beginning of a structural shift from households’ risk-averse investment style?
We believe the sharp rise in 2021 was temporary, driven by the strong performance of US equities and the dollar. But Japan’s households will likely continue to increase their foreign portfolio investment in the long term, albeit at a very gradual pace. Given the sheer size of household wealth, such a shift will have a profound impact on the yen and the Japanese government bonds (JGBs) market.
Risk-averse households
Japan’s households have stubbornly stuck to their uniquely risk-averse investment style, despite a long period of super low interest rates in domestic markets. As of March 2022, more than 50% of households’ assets were in cash and deposits, and nearly 30% was in insurance and pension claims (Exhibit 2). Investment in domestic equity was a mere 10%. Even after the 2021 increase, the share of funds in investment trusts was small at 4.7%. This was followed by domestic debt securities at 1.3%, and foreign securities at 1.1%.
Exhibit 2: Japan’s households are uniquely risk-averse
Although the rise in investment trust holdings was small (from 4% in 2020 to 4.7% in 2021), its impact on financial flows is significant because of the size of household financial assets—which reached ¥2,000 trillion (370% of GDP) at the end of 2021. In the net purchases of investment trusts in 2021, the share made by households rose sharply to nearly 40% (Exhibit 3).
Exhibit 3: Households’ dominant share in flows into investment trust in 2021
A large portion of investment trusts purchased by households invest in foreign securities, especially equities. The composition of securities investment trusts (not only those owned by households), shows foreign securities accounted for the largest share in 2021 of 41%, followed by domestic equity (Exhibit 4). A survey of individual investors by the Japan Securities Dealers Association also showed the share of inflows going to foreign equity investment trusts rose sharply in 2021.
Exhibit 4: Steady rise in investment trusts led by demand for foreign securities and domestic equity
A structural shift?
We believe the sharp rise in net investment trust purchases in 2021 (¥6.4 trillion) was a temporary move against a strong performance from US equities and the dollar. In addition, the pandemic gave more time and excess funds to individual investors—as evidenced by a sharp rise in trading through the internet.
We believe households’ investment style and the bank-centric flow-of-funds structure will change only gradually because a large portion of household wealth is held by those aged 60 and above (Exhibit 5). They have a short investment horizon and put more importance on preserving funds for retirement in terms of yen, than on raising returns (net of hedging costs). Relatively poor financial and IT literacy are further constraints on these older generations.
Exhibit 5: A large portion of household wealth is held by the elderly
In the long term, however, the allocation of investment to foreign securities will likely keep increasing, led by younger generations. Under the current pay-as-you-go public pension system, adverse demographics will inevitably result in diminishing pension benefits in the coming decades. Amid poor prospects for wage growth and a rise in domestic portfolio yields, younger generations (with their longer investment horizons) have strong incentives and capability to take more risks to increase returns.
As of March 2022, more than 50% of households’ assets were in cash and deposits, and nearly 30% was in insurance and pension claims.
For years, the government has been promoting a ‘shift from savings to investment’ campaign. In his recent speech in the City of London, Prime Minister Fumio Kishida revealed his ‘Doubling Asset-based Incomes Plan’, which included a major expansion of NISA—a tax exemption programme for small investments (the Japanese version of an ISA)—and the creation of a new mechanism to encourage citizens to move their savings into asset management.
Even with these tailwinds, any shift in investment style will be very gradual. Younger generations have limited funds for investment and the inheritance of accumulated wealth will take many years in a nation with the longest life expectancy in the world.
Impact on the FX market
Despite the slow pace of changing investment strategies, the impact on financial markets will be significant because of the huge amount of financial assets held by households. In the long term, our projection based on demographics indicates household wealth will continue to expand in the coming decades as societies that are ageing at a faster rate will accumulate greater national wealth relative to GDP as they contain older, wealthy people.
For the past few years, investment trusts have accounted for a significant share of net overseas portfolio investment by residents (Exhibit 6). And the yen will come under depreciation pressure as households invest more in foreign assets through investment trusts with less FX hedging. Receiving a large portion of household wealth as yen-based liabilities, banks and insurance companies have tried to raise returns by investing in foreign securities. However, their risk-taking has been inevitably constrained by regulatory requirements and risk management practices. According to the recent BoJ financial system report, for example, currency hedge ratios for foreign securities investment among life insurance companies have been stable at around 60% for several years.
Exhibit 6: Investment trusts are a major source of portfolio outflows
Impact on the bond market
The JGB market will also get less support from banks and insurance companies, as households shift their investment out of bank deposits and insurance products.
The share of JGBs held by insurance companies and private pension funds hasn’t changed much since 2012, at around 20%. Insurance companies tend to invest in fixed-income products for duration risk management, and the share of government debt in their investment portfolio is notably high in Japan compared with their counterparts in the US and Europe. This reflects the differences in insurance products and financial regulations.
Banks’ share of JGBs had declined due to the BoJ’s aggressive asset purchases but has stabilised in recent years. Banks have already reached a point where they cannot further lessen their JGB holdings to use as collateral and rely more on the central bank’s JGB lending scheme.
Households key to financial sustainability
For many years Japan has enjoyed an equilibrium in its flow of funds—huge government deficits have been supported by financial surpluses in the household and corporate sectors. While the corporate sector has aggressively increased foreign direct investment to cover diminishing profits in domestic businesses, household wealth has remained stubbornly at home, mainly in the form of bank deposits, insurance, and pension claims, despite two decades of low yields.
In the long term, our projection based on demographics indicates household wealth will continue to expand in the coming decades as societies that are ageing at a faster rate will accumulate greater national wealth relative to GDP as they contain older, wealthy people.
Together with aggressive monetary easing by the central bank, households’ risk-averse investment style, with a strong home bias, has significantly contributed to financial repression in Japan.
Although the government debt level has already reached around 260% of GDP, the government has been reluctant to seriously work on a fiscal consolidation plan—arguing huge domestic savings can easily finance a fiscal deficit. However, the government should be aware such a luxury will not last forever and a shift in households’ investment style holds the key. Although we believe such a shift will take place slowly, the pace could accelerate if households lose faith in domestic assets and the yen.
Shigeto Nagai
As the head of Oxford’s Tokyo office, Shigeto helps the firm’s clients understand key macro-economic developments and trends worldwide, and their implications in Japan and across Asia. As a senior member of Oxford’s worldwide economist team, he leads the firm’s Japan research. Shigeto joined Oxford in 2017 from the Bank of Japan (BoJ), where he was previously Director-General of the BoJ’s International Department. In addition to his expertise in global research, he also has extensive experience in foreign reserve management and central bank cooperation in Asia. He was seconded to the IMF in Washington DC from 1993 to 1996 as a member of the Fund’s economics staff.
