By Hideyuki Sano
TOKYO, March 24 (Reuters) - Disenchanted by the negative returns at home, Japanese investors are pumping historically high volumes of cash into overseas markets, with most of it paradoxically going into another developed market with negative policy rates - the euro zone.
While that may at first blush seem odd, their preference for euro zone bonds makes perfect sense in the current unusual world of negative rates.
Since both Japan and the euro zone have negative interest rates on some deposits, Japanese investors can hedge their purchases of euro-denominated bonds and still earn a decent return. Other foreign bonds are too expensive for them to hedge - protect from currency fluctuations.
Japanese investors bought 3.56 trillion Japanese yen ($31.73 billion) of foreign bonds in February, their largest net buying in 5-1/2 years, Ministry of Finance data showed.
As yields on Japanese government bonds of up to 12 years to maturity fell below zero, Japanese banks and life insurers stampeded out of the yen and into foreign bonds. Most of them, however, use currency swaps or forwards to hedge the risk of investing in another currency.
In a trend that has gained momentum since Japan adopted negative policy rates in January, investors appear to favour French government bonds, choosing a market which offers higher yields than Germany but is at the same time liquid and safe.
"They are buying French bonds like crazy. It shows Japanese investors don't want to take credit risks," said Jun Fukashiro, fund manager at Sumitomo Mitsui Asset Management.
In January, just before the BOJ took rates negative, Japanese investors bought 974 billion yen worth of French bonds as they churned their cash from Britain and Germany. Aggregate net outflows for the month were a mere 35 billion yen, the smallest net buying since June 2015, when they were a net seller.
A corresponding factor in the massive Japanese hunt for yield in international markets has been a rise in foreign investment heading for the negative-yielding Japanese government bond (JGB) markets.
The Japanese have become willing to pay huge premiums to hedge their exposures to foreign currencies. That hedging, done through currency swaps, has resulted in a scramble to borrow dollars, ensuring foreign investors are richly compensated for putting money to work in the yen markets.
Foreign investors' buying in Japanese bonds jumped to 1.66 trillion yen February, its highest in four months, according to data from Japan's Ministry of Finance.
While a country breakdown is not available yet, France is likely to be a popular destination.