Last updated: September 16, 2012 7:40 am

Japanese get to grips with triple-deckers

Rakuten, like Gillette, is discovering the power of three.

A decade and a half ago the US personal-care company added a third blade to its razors to build a whole new market.

Now the Japanese broker and asset manager is hoping to pull off a similar trick by going one better than its rival Nomura, which shook the retail market three years ago with its “double-decker” investment fund.

The “triple-decker,” launched by Rakuten Investment Management in August 2010, takes the basic features of the double-decker – a bed of high-yielding stocks or bonds and a foreign-currency overlay – and adds a new layer: premiums from call options sold on assets held by the vehicle.

So far, so good. Net flows into this new class of fund have been steady since April this year, when imitators began to pop up. According to figures from Lipper, which tracks 17 triple-deckers launched by Nomura, Daiwa and others since then, the funds have attracted Y50bn ($640m) to Y70bn a month from Japan’s army of income-seekers. Total triple-decker assets under management stood at Y333bn at the end of August.

That is a long way short of the 567 existing double-deckers, which held a total of Y8.27tn in assets at last count. But bearing in mind the innovative nature of the product and a fundamentally conservative investor base, it is “not a bad figure”, says Shoko Shinoda, senior research analyst at Lipper in Tokyo.

The outlook seems a little brighter, too, as there are signs of a re-awakening of risk appetite among retail investors after the euro-inspired turmoil of the past 12 months. Net outflows from foreign-currency denominated “Toshin”, or publicly-offered investment trusts, peaked at about Y120bn a week at the turn of this year.

Since then, the four-week moving average has hovered between zero and Y50bn of outflows, according to Nomura, leaving total AUM at about Y23tn, or about half of the total stashed away in Toshin of all descriptions. Foreign bonds, in particular, seem to be back in vogue.

While all is clearly not well in the eurozone, the sense of imminent collapse has faded, encouraging investors to swap yen holdings for a little more yield overseas.

“The typical assessment of Japanese investors is that the euro is still hospitalised, but it is out of intensive care,” says Yunosuke Ikeda, head of FX strategy at Nomura in Tokyo.

As a result, he says, “we’re looking for a gradual normalisation of the outward-investment trend” that prevailed between 2002 and the first half of 2011.

Triple-deckers are no straightforward investment, of course. Rakuten, for example, spells out the maximum potential losses for investors in the event of assets experiencing simultaneous, once-in-a-decade crashes, while emphasising that capital gains are capped by a strike price.

Japan’s Financial Services Agency is still watching this corner of the mutual fund market very closely, as it draws up new laws on sales practices. Last year the regulator received a record number of complaints in the July-September quarter, following collapses in the net asset values of dozens of double-deckers exposed to the Brazilian real.

Many investors claimed to be unaware that their principal would be tapped whenever investment returns fell short of the promised monthly dividend.

Even with lengthy disclosures like Rakuten’s, distributors must take care to ensure that investors fully understand them.

“Option-trading is more difficult to explain than FX trading, and is a much smaller, more volatile market,” says Kunihiro Asai, head of product development at Nikko Asset Management, which runs an in-house “academy” for training sales reps on new products and regulatory guidelines.

“Rolling options also has a cost, which can affect a fund’s performance,” he adds.

An additional risk is herd instinct, which can magnify market spasms. At their peak last summer, Japan’s double-deckers held the equivalent of about 11 per cent of Brazil’s foreign reserves in real non-deliverable forwards, according to JPMorgan. Investors’ scramble to offload, as the currency plunged, helped the real to an almost 17 per cent drop in US dollar terms that month.

Still, for experienced investors happy to bank premium income from assets that promise to trade pretty steadily, buying triple-deckers could make a lot of sense, says Nikko AM’s Mr Asai.

After all, those high yields can be compelling enough, without any enormous price appreciation. Any Mrs Watanabe who bought the exotically-named “Rakuten US Reit Triple-Engine Turkish Lira Monthly Dividend” fund at launch last November, for example, is currently sitting on a total return of more than 16 per cent.

Meanwhile, variations are emerging. Late last month T&D Asset Management launched a fund offering a layer of US Reits, a layer of call-options on those Reits, and a second layer of options on the dollar/yen exchange rate.

It took in about Y24bn in a fortnight. The innovation – and the search for yield – goes on.

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