Hedge funds are changing Tokyo’s exclusive club of government bond traders

(Bloomberg) — When Hiroyuki Kubota’s boat party for Japanese government bond traders and strategists resumed last fall after a multi-year hiatus, there was reason to celebrate.

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The veteran group was suddenly back in fashion. The world’s largest hedge funds had begun focusing on the reversal of the Bank of Japan’s ultra-loose monetary policy and shaking up the once-sleepy hinterland of global finance by hiring a steady stream of traders who knew their way around Japan’s sovereign debt. Volatility in the $7.1 trillion Japanese government bond market rose to levels not seen since the 2008 financial crisis.

The group, mostly made up of Japanese-speaking men in their 50s and 60s, gossiped over sake and tempura and was so engrossed in conversation that few ventured on deck to look at the Tokyo skyline, said Kubota, a former JGB trader who started the quasi-annual event in 1998 with members of his online chat room for government bond traders.

“The atmosphere was just as exciting as it was 20 years ago,” he said.

For decades, trading communities like Kubota’s, which call themselves the “JGB village,” have looked inward. Not many of those involved in selling and trading government bonds – estimates range from a few dozen to a few hundred in total – speak fluent English or have any reason to expand their contacts beyond Japan, where all the major investors were based. That has made the world’s third-largest government bond market almost inaccessible to outsiders.

“It’s a closed community, but people are not trying to be exclusive,” said Shinichiro Arie, chief investment officer of the Japanese unit of Amundi Asset Management SAS, who began his career as a fixed income portfolio manager in the 1990s. This is a stark contrast to the more than $20 trillion U.S. Treasury market with its international investor base, he said. “I don’t think there is a community in the global markets that is similar to the JGB village,” he said.

This group is currently in high demand as new entrants enliven the market. In March, global investors’ share of Japanese bond futures trading rose to 79 percent — the highest ever — compared with just under 30 percent two decades ago. Last year, yen interest rate swaps cleared through Japan Securities Clearing Corp. hit a record high.

After keeping short-term interest rates near zero for two decades, the Bank of Japan is widely expected to raise rates for a second time later this year, sparking another boom in trading. The knowledge of JGB residents is important to keep government bond sales running smoothly, and those who know how to make money from rising interest rates will get a premium.

The story goes on

More than a dozen participants have already been poached by banks as part of a hiring spree that began early last year. Among the most aggressive hires were billionaire Michael Platt’s BlueCrest Capital Management and UK-based Capula Investment Management, Bloomberg previously reported. Izzy Englander’s Millennium Management and Singaporean hedge fund Dymon Asia Capital have also made several new hires.

JGB Whales

“The JGB village is unique in Japan,” says Main Kohda, a former JGB trader turned novelist who wrote a successful thriller about government bond traders in 2000. Rumors of JGB sales by large local holders often stir the market, which is why information sharing is so important. “People call it whales in the pond,” she says. Japan Post Bank Co., with 43.9 trillion yen ($271 billion) of the securities, is one of the largest holders of JGBs, along with Mitsubishi UFJ Financial Group Inc. and Nippon Life Insurance Co. Yet they are all dwarfed by the BOJ, which owns more than half of the outstanding government bonds in the market.

The issuance of government bonds began to explode in the 1980s and quickly became a thriving business. At Nomura Holdings Inc., the business became a major profit center for Japan’s largest brokerage. Employees who worked on bonds could be promoted to higher positions, according to a former executive who asked not to be identified when discussing internal matters. Over time, bond traders began to be referred to collectively as the “mura,” or “village.”

Redmond Wong was a junior trader who traded Japanese government bonds, government bonds and other securities at Mitsubishi Trust Asia in Hong Kong in the early 1990s.

While he can get price information on government bonds from data providers and from the news, useful information on Japanese government bonds has always come from phone calls to Tokyo, says Wong, who is now chief China strategist at Saxo Markets.

“You needed a broker in Tokyo. You had to make sure he would call you if something happened or that your Japanese counterpart would inform you,” Wong said.

Trade collapses

But the fast-growing business suffered a setback in the late 1990s when the BOJ cut borrowing costs to zero in an attempt to revive Japan’s stagnant economy. Values ​​fell even further when the central bank, under former governor Haruhiko Kuroda, increased its purchases of government bonds. In the secondary market, there were days when some 10-year Japanese government bonds did not trade at all.

“There was just a certain calm on the trading floor,” said Matthew Hornbach, global head of macro strategy at Morgan Stanley, of his visits to Tokyo in the days when the central bank dominated the market. There was very little trading volume because the Bank of Japan owned so many securities that would otherwise have been traded between investors and market makers, said Hornbach, who began his career more than 20 years ago as a JGB trader in Tokyo and now works in New York.

Normally, large brokerages like Nomura and Daiwa Securities Group Inc. would hire and train new graduates — and thus attract talent that would stay in the industry for years. But with little money to be made, the talent pool shrank, leaving Japan’s pension funds, brokerages and banks with a shrinking community of traders and analysts.

Despite their crucial role in overseeing the bond market, some even joked recently that the community was in danger of dying out, according to a senior official at Japan’s finance ministry. But recently, banks have been ramping up hiring and paying bond traders higher salaries, anticipating a boom in trading as rising interest rates force investors to shift their exposures.

Investment banks typically pay out around three percent of a trader’s profit as a bonus, says Yoshiki Kumazawa, director at the Morgan McKinley recruitment consultancy. For hedge funds, the amount can rise to around 20 percent, but it varies greatly from fund to fund.

Comradeship

In conversations with more than half a dozen bond traders and sellers who said they were part of the village and asked to remain anonymous while discussing private matters, most of them described the community as sharing a shared sense of responsibility for the bond market.

This has created a kind of intangible camaraderie that allows villagers to more smoothly conduct sales conversations and trade or develop an intuitive sense of the direction of the market.

They even have their own jargon. Ganmen block or face block refers to the case where a broker has placed a high bid at an auction in order to be first on the list of winners. Newcomers are sometimes referred to as “tourists” by experienced JGB traders.

Kubota said that back then, many were gathering at traditional izakayas in Tokyo’s Nihonbashi district – the capital’s historic financial center – to mingle with bond market peers, including JGB traders and brokers. One younger interest rate salesman talked about activities such as an outdoor barbecue on a weekend in Tokyo Bay, planned through a messaging app.

The network has other benefits too. The seller, who started working in the industry a few years ago, said he felt like he was part of the JGB village after building a relationship with an influential JGB dealer on the buy side. This has helped him build a larger network and achieve better sales.

However, some fear that the market has evolved and that the advantage of being part of a group of insiders may be disappearing. Today, there is much more information freely available on the market than in previous decades, says Hornbach.

Still, belonging to the JGB village has helped forge notable careers in Japan. Nomura’s vice president Yutaka Nakajima and former Japan Exchange Group Inc. CEO Atsushi Saito – who built his career in Nomura’s pensions division – are said to have been members of the community at one time or another.

“It’s about pride – a sophisticated, sophisticated way of doing things,” which includes sacrificing personal advantage for the sake of the market, Kohda says. “It’s not exactly a gentleman’s agreement, but if you do something unfair, you end up getting shut out.”

– With support from Taiga Uranaka, Takashi Umekawa, Nao Sano, Russell Ward and Ruth Carson.

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