Differences in Evaluation Methods for Junk Bonds Between Japan and Overseas

Recently, I received a question from a foreign book asking, "It is written that Japanese bond index funds contain junk bonds, is that okay?" Although there was no precise description of what kind of book it was or what was written in it, I sometimes hear this from overseas investors as well.
In this article, I will explain the reasons why overseas investors call Japanese bond indices "junk bonds" and the situation of the Japanese bond market.

What are junk bonds?

First, let's confirm the definition of junk bonds. According to rating standards, bonds with a rating of BBB or higher are called "investment-grade bonds," while those with a rating of BB or lower are called "speculative-grade bonds," or so-called junk bonds.

There are four main rating agencies as follows. JCR (Japan Credit Rating Agency) and R&I (Rating and Investment Information, Inc.) are both Japanese rating agencies.

• S&P

• Moody's

• JCR (Japan Credit Rating Agency)

• R&I (Rating and Investment Information, Inc.)

Japanese bond index funds are managed based on the evaluations of these rating agencies. For example, in the "Nomura Bond Performance Index (Nomura-BPI)," if even one of these four companies gives a rating of BBB or higher, that bond is treated as an investment-grade bond.

Reasons why overseas investors judge them as "junk bonds"

Overseas investors (especially those in the United States and Europe) often make investment decisions based on S&P or Moody's ratings. For this reason, if bonds rated BB or lower by S&P or Moody's are included in a Japanese index, they are considered "junk bonds." On the other hand, in Japan, JCR and R&I ratings are also taken into account, and they are sometimes treated as investment-grade bonds, so differences in evaluation criteria lead to differences in perception.

For example, even if a bond is rated "BBB (speculative grade)" by S&P or Moody's, if it is rated "BB or higher" by JCR or R&I, it is classified as an investment-grade bond in the Nomura-BPI. This is the reason why it is seen from the perspective of overseas investors that "junk bonds are included in the index".

Imposition of Western standards and differences in ratings

Such differences in ratings are simply because the evaluation criteria are different, and it does not mean that Japan's unique standards are wrong. However, in the West, there is a tendency to treat one's own rating standards as the "standard," and they often evaluate other countries' bonds based on them.

For example, looking at the evaluation of U.S. Treasury bonds, S&P rates them "AA+" and Moody's rates them "AAA," so even for the same country's bonds, the evaluations can differ. Therefore, it is natural that differences in evaluation criteria exist, and it can be said that overseas investors criticizing Japanese standards is a kind of imposition.

Impact on bond index funds

Japanese investors do not need to be overly concerned about foreign investors calling Japanese bond indices "junk bonds." In the first place, these indices are designed for the domestic market and are evaluated based on Japanese standards.

However, for companies raising funds overseas, the evaluations of S&P and Moody's are important. If these ratings are low, the cost of raising funds in overseas markets may increase, so companies cannot ignore Western standards. On the other hand, in management and investment within the domestic bond market, decisions based on domestic standards are mainstream.

The Japanese Bond Market and the Presence of Foreign Investors

The largest sector in the Japanese bond market is the government bond market, but the holding ratio of foreign investors remains at approximately 13.5%. The Bank of Japan holds approximately 47.9%, and life insurance companies hold approximately 16.5%, making trading in the domestic market the primary focus.

Some foreign investors purchase government bonds in the short-to-medium term zone, but this includes the objectives of securing liquidity and currency diversification. In the long-term zone, pension funds and the like are central, and the proportion of active involvement by overseas investors is low. Furthermore, the presence of foreign investors in the corporate bond market is even thinner, which is against the backdrop of Japan's low-interest-rate policy continuing for a long period.

Summary

The fact that foreign investors treat Japanese bond indices as "junk bonds" is due to differences in evaluation criteria. As domestic investors, there is no problem if you make investment decisions based on Japanese standards. However, since there are companies that cannot help but be concerned about overseas standards, it is important to understand the differences in perspectives.
While the low-interest-rate policy continues, it is difficult for the Japanese bond market to develop as an international market, but stable management centered on the domestic market will likely continue to be required.

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