Kokusai, Biggest Bond Fund in Asia, Bets on Dollar

By Wes Goodman

Sept. 25 (Bloomberg) -- The biggest bond fund in Asia said it is buying the U.S. dollar, and holds the greatest amount of the currency in 18 months, because the nation's economic instability may infect the rest of the world.

Kokusai Global Sovereign Open Fund's U.S. holdings are the highest since April 2007, Masataka Horii, one of four managers for the $51.9 billion in Tokyo, said in an interview. The fund increased its allocation to 27 percent of its assets as of the end of August, from a record low of 20 percent in March.

``The slowdown in growth will spread from the U.S.,'' said Horii, 42, at Kokusai Asset Management Co. in Tokyo. ``Investors won't want to take risks. Money will go back to the dollar, especially from emerging markets.''

The dollar has fallen 3.7 percent the past two weeks against a basket comprised of six currencies of major trading partners on concern borrowing to fund a bailout of the banking sector will swell the nation's budget deficit. The U.S. currency traded at $1.4708 per euro as of 1:03 p.m. in Tokyo from $1.4621 late yesterday in New York. It was at 105.83 yen from 106.11.

Kokusai is favoring the dollar while Treasury Secretary Henry Paulson's $700 billion proposal to stabilize the banking system sends the currency lower.

Dollar Weakens

The dollar weakened the most against the euro on Sept. 22 since the European currency's 1999 debut, falling 2.1 percent. The combination of the plan proposed by Paulson, government spending and a slower economy may swell the U.S. budget deficit to $1.5 trillion, or 10 percent of GDP, said Michael Feroli, an economist at JPMorgan Chase & Co. in New York.

Investors in the Kokusai Global Sovereign Open Fund have lost 3.23 percent in September, versus a 1.75 percent decline in the Citigroup World Government Bond Index, the benchmark the company uses to gauge performance. The fund outperformed the benchmark last year, according to data compiled by Bloomberg.

Horii is also bullish because the Federal Reserve refrained from cutting interest rates this month even as markets crumbled, maintaining the extra yield that Japanese investors get for buying U.S. debt.

The target rate for overnight loans between banks is 2 percent in the U.S., compared with 0.5 percent in Japan. Ten-year Treasuries yield 2.30 percentage points more than Japanese securities of similar maturity, on line with the average for the past six months.

``The Fed won't cut the policy rate,'' Horii said. ``That will favor the U.S. dollar.''

Reducing Europe, Asia

Kokusai reduced its holdings of European and Asian debt to fund its U.S. purchases, Horii said. The company trimmed bonds in Europe to 39 percent of its portfolio from 44 percent, and in Japan to 9.5 percent from 13 percent since March.

Gross domestic product in the U.S. is likely to be 1.7 percent this year and 1.5 percent in 2009, according to the median estimate in a Bloomberg survey. For Japan, growth is forecast at 1 percent in 2008 and 1.15 percent next year. In the euro zone, the forecasts are 1.35 percent and 1 percent.

The U.S. rescue plan may help revive the world's biggest economy, leading investors to use funds borrowed in Japan in search of higher yields elsewhere, said Akira Takei, general manager for international bonds at Mizuho Asset Management Co. in Tokyo.

``What we have seen since last week is an unwinding of the flight to quality,'' said Takei, who helps oversee the equivalent of $36.9 billion at the unit of Japan's second-largest bank. ``It means the yen will tend to be weaker.''

Mizuho bought dollars and sold Japan's currency at the end of last week, Takei said. The greenback may rise to 115 yen by year-end, according to Takei, who correctly forecast the rally in Treasuries last year.

To contact the reporter on this story: Wes Goodman in Singapore at wgoodman@bloomberg.net