I never thought of the yen as a safe-haven currency

When someone mentions the term “safe haven”, I immediately think of Switzerland. I imagine huge vaults, buried deep within the impregnable Swiss Alps—a place where my money would be secure and protected.

I also remember a comedy night, many years ago, with the famous German comedian Dieter Nuhr. He was going on about how much the Austrians dislike their northern neighbours, but how much they also depend on tourism. If only they could find a way of having the Germans just send them their money without actually coming… You’re laughing? Well, the Swiss seem to have managed exactly that!

But why the yen? For months, we’ve been saying that the Japanese currency is the riskiest in the developed world, only occasionally overtaken by that of another island nation in Europe—one that long insisted on keeping its own legal tender and more recently decided to sever its ties with the rest of the continent. So how can a currency that is so volatile actually lower the risk in your portfolio?

The answer is attributable to the yen’s relationship with the currencies of Japan’s major trading partners. The JPY happens to be very strongly negatively correlated with stock markets in the US and Europe. And a negative correlation combined with high volatility can mean a lot of diversification.

So why then is the yen rising when things are going badly elsewhere in the world? There are several theories about this. One is that Japan, like its Alpine cousin, is a significant net exporter. This means that Japanese companies have a lot of foreign cash to put to work, which they may decide to invest in the American and European stock markets. When the latter are starting to head south, some of those Far-Eastern investors are likely to become risk-averse and may want to bring their money home.

The second potential explanation is the so-called “carry trade”. Again, like Switzerland, Japan has very low interest rates, which make it attractive for some market players to borrow money there and invest it in other regions with higher expected returns. If the latter doesn’t materialise, however, those leveraged investors may want to (or even be forced to) unwind their positions. That means selling those foreign assets and converting the proceeds into yen to pay off their loans.

The diversifying effect of investing in the yen will, of course, only work, if you happen to reside in a currency area whose exchange rate to the yen moves inversely to your local stock market—the United States or Euroland, for example. It’s a different story, however, when you live in Britain (the eccentric island nation I mentioned a moment ago, which always insists on frying its “Extrawurst”), as the value of the pound has tended to be driven by rather idiosyncratic, domestic issues recently.

And if you’re a Japanese investor and happen to be risk-averse, you may want to avoid foreign assets altogether, as the majority of your risk will tend to come from exchange-rate volatility. Unless, of course, you expect good news for the US economy, in which case you have the chance of profiting twice: from a rise in the American stock market and from exchange rate gains versus your own currency. But that’s for you to decide.

If you are interested in a more detailed analysis on the impact of different base currencies on your multi-asset class portfolio, you may want to check out our FX Trumps Correlation paper published in January. We are also about a publish another one, which focuses on how the correlation between exchange rates and stock markets has changed over the last couple of months and how, again, this affects the risk profile of a multi-asset portfolio. And if you would like more frequent updates on this topic, why not sign up for our weekly Risk Monitor highlights here.

Christoph Schon, CFA, CIPM

Christoph Schon is the Executive Director, Applied Research for EMEA at Axioma, where he generates insights into recent risk trends with a particular focus on fixed income and multi-asset class analysis. Christoph has been in the portfolio risk and performance analysis space for more than 10 years, having previously worked for Lehman Brothers/Barclays POINT and UBS Delta. 

You might also be interested in

The Systematic Asset Allocation Lego blocks

We’ve all heard them before – ‘Smart Beta,’ ‘Risk Premia,’ ‘Strategic Beta,’ ‘Factor Investing,’ ‘Thematic Strategies’ – words that now seem to headline many investment discussions, industry commentary and panel presentations.

Posted 07.20.17 Alessandro Michelini