(Originally published here.)
Years of currency manipulation by Japan’s Ministry of Finance has left it with $1.27 trillion in foreign exchange reserves, most of which are invested in low-yielding U.S. Treasury bonds. Following an account in Japan’s Nikkei newspaper, Bloomberg News reported that the ministry is planning to outsource management of some of this money. Details about the plan are thin. Still, it could mark the first step toward the creation of a Japanese sovereign wealth fund that invests for profit.
Countries that buy dollars and euros to suppress the value of their own currencies aren’t trying to make money from their asset portfolios. Rather, they think that their purchases of foreign exchange are worthwhile because they increase the competitiveness of their export industries. (Some governments also hoard foreign currency as a hedge against the foreign borrowings of their local businesses, although this doesn’t apply to Japan.) This can create opportunities for savvy currency traders to make money off the “uneconomic” decisions of certain central banks.
Sovereign wealth funds are different. Big oil producers that have underdeveloped domestic industries will invest abroad in an effort to secure needed resources if (or when) their oil runs out. That’s why the biggest sovereign funds are operated by Norway, Saudi Arabia, Kuwait and Abu Dhabi, although Singapore, China and Canada also have large funds. (If the Social Security trust fund were managed to maximize returns rather than hedge its fixed liabilities, it would be the world’s largest sovereign wealth fund by a wide margin.)
Sovereign wealth funds often make direct investments in companies, infrastructure projects, natural resources and real estate. Although every sovereign wealth fund is different, many of them follow the Yale endowment model by making significant allocations to illiquid investments and hedge funds. Their track record is mixed, but some of them have done very well for their citizens.
What “outsourcing” means in the context of Japan’s currency portfolio isn’t clear. Perhaps it will let professional traders make decisions about whether to hold Treasury bonds or mortgage-backed securities guaranteed by the U.S. government. That wouldn’t be very interesting compared with what some other funds are doing, but it could mark the beginning of an intellectual transition at Japan’s Ministry of Finance. If so, expect hedge-fund managers and private-equity titans to start flying to Tokyo looking for investment mandates.
(Matthew C. Klein is a writer for Bloomberg View. Follow him on Twitter.)