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Wednesday, June 7, 2023

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Warren Buffett Is Rocking Japan’s Magical Cash Cow

smallhare three Japan’s five largest trading groups hit record highs in the past week after Warren Buffett declared he was eager to own more of their stocks. This is just the latest good news for the company. Shares in Itochu, Marubeni, Mitsui, Mitsubishi and Sumitomo have soared since Buffett’s investment firm, Berkshire Hathaway, announced its first acquisition on its 90th birthday in 2020. Their shares have risen between 64% and 202% since then.

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In some ways, Japan and Mr. Buffett are a match made in heaven. Mr. Buffett is known for his unerring focus on business fundamentals. Even after the recent sell-off in U.S. stocks, prices across the Tokyo market are much cheaper. Its price-to-earnings ratio (based on expected earnings next year) is about 13, compared with 18 in the US.Trading company invested by Berkshire Hathaway – known in Japan as Sogo Trading Company– are generally considered staid and dependable. All companies have P/E ratios below 10 and pay healthy dividends.

Berkshire Hathaway’s Japan deal has other implications, too. It illustrates why the country may become a more attractive destination for other U.S. investors. On April 14, the investment firm sold about $1.2 billion in yen-denominated bonds, adding to the $7.8 billion it has issued between 2019 and 2022. Not only is Japan now Berkshire Hathaway’s second-largest investment location — the yen is also its second-largest funding currency. Even before the recent offering, nearly one-fifth of Berkshire’s debt was denominated in yen.

The company didn’t borrow money because it was short on cash. Instead, the trade reveals the advantages of currency hedging. Borrowing and buying yen protects Mr. Buffett from falling currency values. Because of the interest rate gap between the U.S. and Japan, he can finance his investments with long-term loans that pay less than 2 percent a year, while investing spare family cash in government bonds that yield closer to 5 percent. Buffett has questioned the value of currency hedging in the past. Its appeal today seems irresistible. Borrowing in yen is so cheap compared to borrowing in dollars in yen that the trade is a no-brainer for investors with even a passing eye for Japanese stocks.

Of course, not every such investor can easily issue yen-denominated bonds. But those who cannot can exploit monetary policy gaps through more direct currency hedging. Prices in the forward and futures markets are determined by the difference in interest rates between the two economies involved. The surge in US but not Japanese interest rates over the past 18 months means that Japanese investors are paying huge premiums to buy US assets and protect themselves from currency volatility. When U.S. investors do the same thing in the other direction, they get a sizable premium.

The yen is currently trading at 134 yen to the dollar, but currency futures expiring in March next year give investors the opportunity to sell at 127 yen to the dollar. This locks in a 5% return in less than a year. The only cost is that the buyer must hold the yen for the entire period. For investors who want to hold Japanese stocks, the return on hedging is essentially a bonus. That opportunity looks unlikely to disappear. Even if the Bank of Japan abandons its yield curve control policy, few analysts expect Japanese interest rates to rise significantly.

The potential benefits are huge. In the past year, Master of Science U.S. The index provides a net return of -5%, including capital gains and dividends.this Master of Science The unhedged but dollar-denominated Japanese index provided a 1% return.this Master of Science The Japan Hedge Index, based on Japanese equity returns using one-month rolling currency forwards, has gained 12% over the same period.

It may simply be because of the enviable returns on U.S. stocks over the past decade or so that more investors are not taking advantage of Japan’s dividends. But big names started flying to the other side of the Pacific. Activist investor Elliott Management is rewarded for its intervention in Dai Nippon Printing. Shares of the company have soared 46% this year. Meanwhile, US hedge fund Citadel is reportedly set to reopen an office in Tokyo after a 15-year absence. The example of Mr Buffett and other U.S. financial titans is likely to draw more attention after a period when Japanese markets quietly delivered solid returns.

Learn more from our financial markets columnist Buttonwood:
What to say about the new Cold War luxury stocks (April 13)
Stocks have shrugged off the turmoil in the banking sector. isn’t it? (April 5)
Did social media spark a bank panic? (March 30)

Plus: How the Buttonwood column got its name

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