US hedge fund firm Capstone Investment Advisors said it’s allocated more risk capital to Japan than ever before, as the central bank’s decision to maintain negative interest rates creates uncertainties that may benefit its volatility trading strategy.
“Japan is taking a view that they are going to hold firm with their interest-rate policy, and that is a significant outlier when you compare it to the Federal Reserve, European Central Bank and the Bank of England,” Chief Executive Officer Paul Britton said in an interview in Tokyo. “So that just creates volatility as investors question what the BOJ is going to do.”
Capstone, which manages about $10.8 billion, started trading from its first Asia office in Hong Kong last year and intends to allocate $1.5 billion of risk capital to the region by mid-2024 — a plan that’s currently on track with Japan providing the biggest exposure in Asia, Britton said. Japan will likely continue to be the fund’s largest allocation in the region for the next 12 to 24 months, he added.
The Bank of Japan has stuck with its negative-rate policy as central banks around the globe raise borrowing costs. That divergence has driven intense speculation among investors on when new Governor Kazuo Ueda might raise rates. It has also put pressure on the yen, which has weakened more than 16% against the dollar since the start of 2022.
Uncertainty around the Bank of Japan’s actions and how it might reduce the size of its balance sheet if it does change course creates opportunities for Capstone, Britton said, adding that most of the firm’s Japan trades are focused on foreign exchange and rates.
Six-month implied volatility in the yen, a gauge of expected swings in the currency over that time frame, remains well above its recent historical average. That suggests some traders are betting on the chance of big moves.
Capstone employs derivatives-based strategies, seeking to profit from volatility in various assets and pricing gaps between related securities.
The fund is a rare new entrant to the hedge fund industry in Hong Kong, after opening its office at a time when many funds were moving or pulling back on concerns of geopolitical risk tied to China. There are now 12 employees at Capstone’s Hong Kong operation, Britton said, as he prepared to visit the office for the first time.
China Opportunities
While the fund is focused on Japan for now, Britton said he believes the bigger opportunity will be in China in the long term. Despite news headlines that suggest China is becoming more insular, its efforts to open up its financial markets will give Capstone more opportunity and access in the country, he added.
Britton said he sees actions China might take to protect its heritage and domestic businesses as a main driver of volatility in the next five to 10 years.
“With China being young in developing its markets, I think that there is always chances for missteps and surprises, which we’ve seen over these past three to five years,” he said. “I think that will continue to happen over the next five, 10 years as China continues to open up its markets.”
--With assistance from Bei Hu and Cormac Mullen.
