The double-decker thrill ride for Japanese retail investors may be over after a depreciation in emerging market high-yield currencies shattered profits and regulators stiffened rules. Asia Risk assesses the risks of these products and asks what investors will look to next In Japan’s multi-decade deflationary environment, the options for investors are limited: stick to Japanese government bonds (JGBs) and receive certainty over retaining your principal if little in the way of returns, or opt for something a little racier in the search for yield. Japanese investors, particularly those in the 60–69 year age group, who are contemplating a long retirement on a low-yielding asset base, have opted for the latter – with volumes of so-called ‘double-decker’ products rising from virtually nil in 2009 to more than ¥9.2 trillion ($114 billion) in assets under management at their peak in July last year, according to figures provided by Morningstar. The name double-decker refers to a multi-layered structure which initially invests in high-yielding fixed-income assets with the coupons reinvested via non-deliverable forwards (NDFs) in appreciating currencies such as the Brazilian real or the Turkish lira. Returns on these structures have been good – at least in the short term. The Nomura Global High Yield Bond Fund (Yen Course), for example, experienced 3.7% growth after just its first three months of trading in April 2010 – significantly higher than could be achieved in a year’s investment in JGBs. Unsurprisingly, the good times haven’t continued indefinitely. Fast forward to September this year and a surprise 50 basis point cut in Brazilian interest rates combined with a flight to quality following the US downgrade which drove up the value of the yen, saw returns on double-deckers plummet. So after its initial good performance, the Nomura fund fell – and badly. Its total return in 2011 was minus 11.6%, and its net asset value (NAV) of an initial 10,000 yen investment stood at a mere 6,461 yen. Notwithstanding this performance, the structures are still selling, albeit at lower volumes. One reason for the popularity of double-deckers is the monthly yield that is paid out – a useful attribute for retirees. The dividends from the underlying bond portfolio provide investors with a monthly income, so that even if the currency overlay is falling in value and reducing the NAV, it is still possible to receive an income. Risk assessment Understanding of the monthly income potential of double-deckers may be widespread but according to one expert, this isn’t matched by an awareness of the risks posed by what is a complex product. Frank Packard, Japan representative at Triple A Partners in Tokyo, says: “There are three ways an investor can get more yield: increase their credit risk by trading JGBs for Toyota bonds, take on more complexity by investing in a structured credit product like a collateralised debt obligation, or by shouldering some country risk. These double-deckers take on all three.� He adds: “Some of these products are so exotic that I would be doubtful whether all the risks have been sufficiently explained to investors, or even understood by distributors.� Whether or not investors understood the risks associated with the product prior to purchase, the impact of a strengthening yen on the value of their investments would have been clear. In 2011, the real declined 15.6% versus the yen while the Turkish lira fell 22.3% and the South African rand by 22.5%, according to data from Lipper. A spokesperson for Nomura in Tokyo points out that after dividends are accounted for, the fund depreciated at a slower rate, only being 11% down during the same period. Nevertheless, a retail investor redeeming an investment in this fund last year would have lost a considerable percentage of principal depending on when they redeemed, even taking into account the benefit of monthly dividends.

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