If Japanese government bonds are downgraded again, MPF bond funds may be forced into a painful sell-down

Japanese sovereign credit ratings were cut in 2011: Moody’s lowered the rating from Aa2 to Aa3, the first cut in nine years; Standard & Poor’s had already lowered Japan’s rating outlook in April, and Fitch hinted it might follow. The shockwave reaches Hong Kong workers’ MPF — the 25 global bond funds in the system may be forced to slash their Japanese bond holdings from 30% to 10%.

Why would a Japanese downgrade hit MPF bond funds?

MPF rules grant special exemption to sound sovereign bonds: global bond funds holding bonds of sound sovereign issuers such as the United States and Japan are exempt from the 10% cap and may hold up to 30%. If Japanese government bonds are downgraded again and lose their “sound” status, the 25 MPF global bond funds would have to cut their Japanese holdings from the maximum 30% to the general 10% limit; the market estimates more than HK$1 billion is involved, and the fund industry fears the forced selling would hurt fund returns.

Exemption limits at a glance

The benchmark dilemma

The chairwoman of the Hong Kong Investment Funds Association noted that MPF global bond funds generally track the Citigroup World Government Bond Index, in which US and Japanese bonds each account for about 30% of the weighting. If Japanese bonds are downgraded, funds must cut their holdings from 30% to 10% to comply with the rules. She warned the forced reduction could damage fund returns.

Trustees are now discussing contingency plans with the regulator. To check MPF bond fund holdings and performance, see MPF fund search.