Hedge Funds Chase Profits From Knife-Edge Japan Vote

The Japanese flag at the National Diet building in Tokyo. Photographer: Kiyoshi Ota/Bloomberg

(Bloomberg) — Hedge funds are employing a range of strategies to profit from Japan’s too-close-to-call leadership race, including plans to sell stocks, bet on a stronger yen, or trim risk assets.

The sweep of trading plans has emerged as opinion polls are split ahead of Saturday’s vote on whether reformist Shinjiro Koizumi or right-leaning Sanae Takaichi will be the next leader of Japan’s ruling party. The outcome may have long-term implications for Asia’s second-largest economy, given the policy differences between the two contenders.

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Hedge fund Epic Partners Investments Co., for one, is primed to sell into any possible rally in stocks once the leadership victor becomes clear.

“I’m aiming to exploit temporary mispricings once the winner is decided,” said Hidematsu Take, chief executive at the leveraged fund in Tokyo. “If Takaichi wins, related shares may rally like a festival, and I’d look to sell. With Koizumi, it’s the same.”

The Liberal Democratic Party leadership contest goes beyond party politics, with expectations that the winner will influence where interest rates are headed over the longer term. Many Bank of Japan watchers see a slower pace of hikes if Takaichi is chosen, given she’s an advocate of monetary easing. Koizumi is seen as being more open to incremental change and keen on boosting wages and productivity.

An extra challenge is that both Takaichi and Koizumi have moved to the center to avoid a repeat of the prior leadership contest when Shigeru Ishiba went from long-shot to winner by taking the middle ground. Takaichi hasn’t repeated her anti-rate-hike comments that roiled markets last time, while Koizumi has softened his reformist image by employing Finance Minister Katsunobu Kato as his campaign chief. A number of other candidates are also running, including chief government spokesman Yoshimasa Hayashi.

While acknowledging the challenges, hedge fund K2 Asset Management says it’s looking to profit from a possible uptick in the yen once the vote is over.

“Where we can we are structurally positioned for a stronger yen,” said George Boubouras, head of research at K2 Asset in Melbourne, adding that will be done through unhedged currency positions in some Japanese equity bets. “It’s hard to trade the elections but it’s about adjusting for the unique nature of domestic Japanese politics,” he said.

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A positive yen narrative is quickly building with the BOJ heading toward a rate hike, the Fed set to lower rates again and an LDP leadership vote which will set up more stimulus for the Japanese economy.

Mark Cranfield, Markets Live strategist

The divergence in positioning across markets captures some of the tension. The split between asset managers who are long the yen, and hedge funds that are selling, is now the widest since 2007, based on the latest data from the Commodity Futures Trading Commission.

Meanwhile, a Citigroup indicator for currency funds’ positioning sank this week to the lowest level since June, pointing to a possible increase in bearish bets. Similarly, the cost to hedge against the prospect of a stronger dollar-yen has also overtaken that for a weaker one, according to risk reversals.

Some investors are simply taking risk off the table. Calvin Yeoh, who helps manage the Merlion Fund at Blue Edge Advisors in Singapore, is buying gold ahead of the vote — an increasingly popular hedge for everything from political to rates risks.

“We were short yen but are now flat and awaiting results,” he said.

Others are looking past the weekend leadership contest altogether to focus on what they see as the more important dynamic: the outlook for BOJ interest rates.

Atsuko Tsuchiya, an ex-Citadel trader, who now runs Atom Capital Management in Tokyo, is concentrating on when the BOJ’s next hike will come — irrespective of whether local politics or global events influence its path.

“Bank stocks have already priced in an October hike, so I expect a correction,” Tsuchiya said. “We’re holding longs but also hedging with shorts.”

WATCH: Hedge funds circling Japanese election: 3-Minute MLIV

–With assistance from Michael G. Wilson, Masaki Kondo, Momoka Furusawa and Yasutaka Tamura.

(Corrects to remove comment from Orbis Investment that was inaccurately attributed in the 9th and 10th paragraphs)