With Japanese wages now also growing in real terms can wage inflation also add to the impetus behind the Japanese economy. How long will this trend continue? How high will Japanese wages go – or could underlying demographic challenges shorten this recovery in wages and consumer confidence?

If wage growth does feed through into higher consumer spending sectors of the economy, which are best placed to benefit from that?

Japanese real wage likely to continue growing for next few years

The Government is now actively supporting wage growth to avoid inflation eating away at household budgets – which would reduce consumption. Government assistance to help real wages is set to continue rising – surpassing price increases – over the next few years.

2024’s minimum wage increase rate of approximately 5 per cent is far higher than the norm for that past three decades. Meanwhile, growth in the Japanese Consumer Price Index (CPI) was 2.7 per cent in the year to August 2024.

The Government has set a target to further raise the minimum wage to 1,500 yen per hour by the mid-2030s. If this target is achieved, we should expect annual wage increases exceeding 3 per cent.

Most analysts initially assumed that inflationary pressures would not spill over into domestic prices – judging that companies would be unable to raise prices for fear of losing consumers. However, Government measures subsidising consumer prices and supporting wage increases have enabled companies to pass on price increases while stimulating above-inflation wage growth.

Service prices in Japan – directly influenced by wage trends – will likely rise in the short term. Real terms durable goods consumption has already recovered to pre-pandemic levels, while services expenditure has yet to reach pre-pandemic levels.

Retail and service sectors poised to benefit most

The retail and service sectors are likely to significantly benefit if wages continue to grow. Data from the past 20 years shows a strong positive correlation between wage growth and consumer spending – suggesting rising wages will increase household expenditure.

The age groups experiencing the fastest wage growth are workers in their 20s to early 30s – and the smaller purchasing power of the 60+ bracket.

While consumers in their 20s tend to spend more on rent, eating out, culture and recreation, expenditure for those aged 60+ skews more towards groceries, healthcare, and car and tech repairs. Given that Japan’s minimum retirement age is 60, consumption trends among those in their 20s will have a greater impact on the Japanese economy.

We expect that equities in these consumer subsectors will benefit from that considerable jump in demand. Over the past three months, the TOPIX industry indices show the retail sector has outperformed with an average share price rise of +8.5 per cent. Service sector shares have risen by +6.3 per cent on average – significantly outperforming the overall TOPIX, which declined by 3.1 per cent.

Market expectations of wage growth and price inflation have been major drivers of rising Japanese share prices over the past year.

Labour shortages and a weak yen contributing to real wage growth

Japan’s major demographic challenges – chiefly an aging population and declining birthrate – will further contribute to sustained wage increases. Both factors will exacerbate labour shortages in the long term. Current labour shortages are also prompting short term investments in automation – enhancing labour productivity and further supporting wage growth.

Additionally, the yen’s weakness against the dollar has now likely peaked. Wage growth is now being supported by a stronger yen – helping ensure sustainable wage growth for Japanese workers.

However long-term economic anxiety among Japan’s youth could incentivise greater saving – hampering further growth in the economy

While wage growth now outpaces inflation, it’s still only a modest increase – just over three per cent. Japan is already burdened by an expensive welfare state and growing welfare contributions will bite into this extra disposable income.

Longer-term anxiety – particularly amongst younger people – may constrain further increases in consumer spending. Japan’s long term economic prospects remain uncertain, particularly with an ageing and declining population – and corresponding ballooning welfare costs. Many younger people see greater saving as the prudent option for the long term.

There’s a large economic incentive for the Government to keep supporting wage growth – boosting domestic consumption. We, therefore, expect this trend of real terms wage growth to continue over the medium term. However, to secure sustainable wage growth in the long term, the Government will have to consider the structural changes needed to address a declining population.

Japanese households and Government are enjoying the short-term benefits of increased economic activity. Both want to realise the benefits of the current economic uplift – wages will keep growing, at least until the 1,500 yen per hour target is hit.

Bold forecasts that miss the mark are often quickly forgotten or swept under the rug by misfiring prognosticators.

Two years ago, we heard forecasts of “a 30–40 per cent decline in the U.S. dollar.” But as everyone now knows, the drop in the dollar didn’t happen. Compared to other developed countries’ currencies, such as the Japanese yen, the dollar is up more than 30 per cent since 2022. Further, since 2011, the dollar is up almost 40 per cent compared to a broad basket of currencies!

So why were the dollar bears so wrong? Popular misconceptions about the dollar’s role in the global financial system mislead investors and policymakers alike. These misconceptions never seem to die. We detail our favorite mistakes so that, hopefully, you won’t repeat them.

The result of human action not design

For much of its early history, the United States had nothing like a universal currency The US followed a bimetallic standard (linked to gold and silver), and paper money was shunned. However, the Panic of 1907 prompted Congress to create the Federal Reserve (Fed).

The Fed later issued “Federal Reserve notes,” lent to banks when liquidity dried up, and enforced “par” settlements for checks across the Federal Reserve System.

Then came a series of crises and some luck. The US’s favourable geographic location during the First and Second World Wars (far removed from most battlefields) allowed it to become the “centre of the global financial system.”Owning about 40 per cent of global gold reserves allowed the US to be one of the only countries that did not suspend convertibility throughout the wars.

But wasn’t the dollar system designed by policymakers at Bretton Woods after the Second World War? In reality, delegates ruled out competing plans as infeasible. In short, the dollar was just the best and easiest option.

In addition, the dollar’s reign had already gone global. The Euro-dollar market was born in the 1920s and was revived in the 1950s because London banks started accepting dollar (and other currencies) deposits and making dollar loans to third parties.

Modern-day crises have only further cemented the dollar’s global reign. During the global financial crisis, the Fed lent USD10 trillion in raw swap amounts to its major foreign counterparties, and again during Covid-19—a sign of just how vital the dollar is to the global economy.

The dollar will soon be displaced by a rival

The dollar is the most dominant currency, and its status has waned little in recent decades. According to the international currency index constructed by the Fed, the dollar has remained a steady leader in forex reserves, transaction volume, foreign currency debt issuance, and international banking claims for as long as data is available.

As for second place? It’s not even close. The Euro scores 23 on the index, one-third of the US level, though greater than the sum of the next three currencies combined – Japanese yen (JPY), British pounds (GBP), and Chinese renminbi (RMB).

Further, in 2015 countries with currencies anchored to the dollar (not counting the United States) accounted for 50 per cent of world GDP. In contrast, euro-linked economies accounted for just 5 per cent (not counting the euro area).

The world is de-dollarising.

The latest dollar bear fad is “de-dollarisation.” The argument is that major economies will prefer to use other currencies to avoid the ire of US policymakers keen to “weaponise” the dollar using sanctions.

De-dollarisation is catchy and alliterative. But it’s also wrong.

First sanctions are common and have been used for a long time. As early as 1935, the US-led League of Nations (predecessor to the United Nations) sanctioned Italy for its invasion of Ethiopia, banning loans and military equipment. In modern times, for military purposes, the US has frozen assets tied to the governments of Libya (2011), Iran (2012), Venezuela (2019), and most recently, Russia (2022).

Second, the benefits of “dollarisation” far outweigh the perceived risk reduction from de-dollarisation. Using the dollar allows you to reach 80 per cent of the buyers and sellers in global trade activity and the deepest and most liquid financial markets in the world.

While instituting sanctions dissuades some countries from holding Treasuries as reserves, it’s unlikely the bulk of dollar reserve holders will dump the dollar. In fact, overseas governments with military ties to the US own nearly three-quarters of the total US debt held by foreign governments.

In short, the benefits of operating in dollars far outweigh the costs of de-dollarisation.

Debt overhang will sink the Dollar

Another common misconception is that the dollar is (always) on the brink of collapse due to excessive debt burden. Headlines often tout the “USD27 trillion in marketable debt outstanding.”

From a first approximation, we find this view tedious. For the last 30 years, one could have said the same thing every day of every month in every quarter of every year. So far, the predictive value is nil, for the cumulation of national debt has yet to lead to higher yields or a debt default.

The debt issue is overstated. The average cost (yield) of US debt is only 3.4 per cent as of July 2024, still much lower than most of the country’s recent history, thanks to the dollar’s status as the global reserve currency and decades of price stability since the 1990s. Unless the Fed funds rate stays above 5 per cent for a few more years, we’d argue that the current trajectory of the US debt burden remains manageable.

 Dollar doubters beware

Contrary to popular belief, there are no viable rivals to the dollar. De-dollarisation may occur to a limited extent and be led by bad actors in the global financial system. Still, users of the dollar system overwhelmingly benefit from trading, borrowing, and saving in dollars. Further, debt burdens do not yet threaten the dollar system’s stability, with debt service costs manageable and dollar debt buyers more eager than ever to hold greenbacks.

With fragmented banking markets unable to meet the growing demand for credit—particularly in middle-market sectors—private lenders are stepping in to fill the financing gap. This rapidly expanding market offers investors attractive risk-adjusted returns and diversification opportunities, positioning APAC private credit as a key driver of regional economic development.

Economic growth

APAC is projected to account for up to 70 per cent of global GDP growth, creating substantial demand for credit financing. Traditional banking institutions in the region face regulatory and structural constraints, such as Basel III requirements, limiting their ability to meet this rising demand. This is especially true for micro, small, and medium-sized enterprises (MSMEs), which make up 97 per cent of all businesses in Asia, accounting for 56 per cent of the workforce and 28 per cent of economic output. This unmet need for financing presents a significant opportunity for private credit providers to step in and bridge the funding gap.

Structural inefficiencies in traditional banking

The APAC banking sector, while a dominant force in credit supply, faces significant inefficiencies, particularly with non-performing exposures and inflexible lending practices. Many banks favour lending to government-backed industrial sectors, leaving other segments, notably MSMEs, underserved. Recent global banking concerns and tightening credit conditions have further amplified these challenges, presenting a clear opportunity for private credit to step in with flexible and accessible capital solutions. Additionally, the region’s leveraged loan and high-yield bond markets are underdeveloped and fragmented, as local lenders seldom venture beyond their borders—highlighting the untapped potential for private credit to fill this gap.

Infrastructure and sustainability

Private credit in APAC is increasingly pivotal in both financing critical infrastructure projects and promoting sustainable development. Funds like SC Lowy’s Strategic Investments IV (Asia) are providing essential capital to businesses that are otherwise restricted from traditional bank lending. This funding enables the development of crucial sectors such as real estate, toll roads, and transportation networks, particularly in countries like India. These infrastructure projects are vital for supporting long-term economic growth and enhancing regional connectivity.

At the same time, private credit is advancing sustainable development by offering financing to small and medium-sized enterprises (SMEs) and large infrastructure projects in underserved areas. Many APAC countries face limited access to capital, and private credit steps in to fill this gap, promoting entrepreneurship, job creation, and inclusive economic growth. By fostering both infrastructure development and financial inclusion, private credit investments contribute significantly to the region’s long-term sustainable growth, especially in markets that have historically been underserved.

Dynamic market opportunities with returns

APAC presents a broad spectrum of investment opportunities, from highly developed markets like Australia and South Korea to rapidly growing emerging economies in Southeast Asia. This diversity allows private credit investors to implement tailored strategies, such as direct lending and collateral-backed lending, that suit the unique characteristics of each market. Investors who navigate the region’s complex legal and regulatory environments gain a competitive advantage, positioning them to achieve attractive risk-adjusted returns. APAC private credit investments offer a premium over comparable opportunities in the US and Europe, with direct lending deals typically yielding a 300-500 basis-point premium. More complex capital solutions can offer even higher returns. The relatively low level of competition among lenders enables private credit providers to negotiate favourable terms, such as robust covenant packages and asset-backed loans, enhancing both risk protection and return potential.

Diversification

For global investors, APAC private credit provides substantial diversification benefits, offering exposure to both developed and emerging markets. Sectors like real estate, industrials, healthcare and infrastructure are ripe for investment, providing opportunities to diversify beyond the traditional focus areas of public market portfolios. Additionally, investors with local expertise and strategic flexibility can tap into niche opportunities, navigating diverse legal frameworks and capitalising on regional market nuances.

Risks

Despite the potential for strong returns, investing in APAC private credit is not without challenges. Political and regulatory risks are significant, as sudden policy changes—such as those seen in China—can affect the stability of private markets. Local regulatory environments may also be less mature compared to developed markets, adding layers of complexity. Mitigating these risks requires deep local knowledge and partnerships with firms that understand the intricacies of each market.

Conclusion

The APAC private credit market is poised for continued growth as economic expansion, structural banking inefficiencies, and rising demand for capital create new opportunities. With attractive risk-adjusted returns and diversification benefits, private credit is well-positioned to meet the financing needs of businesses across the region. For investors equipped with local expertise and a strategic approach, APAC private credit presents a compelling opportunity to achieve superior returns while supporting sustainable economic development across a rapidly evolving region.

Far reaching changes to the ELTIF rules that took effect in January this year have brought momentum in terms of new launches and innovation in investment strategies as fund promoters gain confidence that the new formula meets the needs of asset managers and of individual as well as institutional investors.

Slow beginnings

The regime was conceived as a means to encourage the deployment of retail savings in the European Union toward assets seen as possessing long-term economic, social, environmental and strategic value, including critical infrastructure, the transition to sustainable energy and decarbonisation of the economy, and unlisted small and medium-sized companies that needed new sources of capital to exploit their potential.

The first iteration of the legislation did win some converts, especially in Luxembourg, which quickly became established as the go-to domicile and service centre for ELTIFs targeting cross-border markets. But the sector’s growth was slow; over the seven years after the regime’s introduction in December 2015, just 81 funds were launched, attracting an estimated EUR7.4 billion in assets.

Managers expressed frustration about many aspects of the rules, often added in the name of investor protection, including diversification requirements that stipulated individual assets could not exceed 10% of a fund’s portfolio, and tight restrictions on the use of leverage. Meanwhile the bar was high for acceptance of non-professional investors, so much so that promoters opted to concentrate on institutional money or different types of fund.

The dawn of ELTIF 2.0

Hence the concerted effort launched by the European Commission in 2021 to revise the ELTIF Regulation in order to fulfil its original ambition of mobilising retail as well as professional investment. Following extensive consultation with asset managers, and with support from EU member states which perceived that the urgency of the envisaged investment priorities had in no way diminished, what has been dubbed ‘ELTIF 2.0’ is now in effect.

The revised regime addresses most issues raised by asset managers regarding ELTIF investment strategy rules, including greater flexibility on diversification, borrowing limits and eligible assets. It also removes many of the barriers to non-professional investors, including the previous minimum investment requirement of EUR10,000 for non-high net worth individuals.

Also important are the detailed regulatory technical standards adopted by the European Commission on July 19 this year. Following a debate with the European Securities and Markets Authority, the Commission has opted for a flexible approach to liquidity and redemption policy at ELTIFs open to individual investors, giving promoters freedom to adapt the fund’s structure and terms, including redemption frequency and notice period, to its investment strategy and goals and the needs of the investors it targets. Asset managers are satisfied that a philosophy of flexibility has won out over rigid one-size-fits-all requirements.

To this extent the regulatory regime promises to drive growth in the establishment of ELTIF funds and the assets they attract. One of the key aims behind the launch of regulated long-term funds was to channel retail capital into strategies aligned not just with the investment needs of the economy but with the long-term retirement provision requirements of an ageing population. The constraints of asset classes that do not offer short-term liquidity, including real estate, infrastructure and private equity and debt, fit better with longer investment horizons.

The conception of ELTIFs also tied into the economic environment of the 2010s, with low inflation and rock-bottom interest rates diminishing the appeal of savings accounts and fixed-income investment. While that changed with surging prices and the rapid rise in central bank rates in the wake of the Covid-19 pandemic, the signs point to lower levels in the coming years. The search for higher returns than those offered by short-term investment look set to be a permanent characteristic of the investment landscape in the years to come.

Optimism for the future

Are these factors bringing new impetus to ELTIFs? The signs are positive: as of the end of August, a total of 132 funds had been established across Europe, with Luxembourg accounting for almost two-thirds (84). And despite the ongoing process of finalising the detailed rules, 34 have been launched so far since January 10, 2024, when the ELTIF 2.0 legislation took effect.

Forecasts for the growth of the ELTIF range from €35 billion by the end of 2026, according to German rating and analytics firm Scope, to a more speculative European Parliament report suggesting that ELTIF assets might reach EUR100 billion by 2028. But there is broad confidence that the legislative and regulatory tools are now in place for Europe’s long-term fund regime at last to fulfil its potential.

We use three criteria to classify frontier economies—investment credit rating status (high yield), income status, and issuance size. Our definition of the EMD Frontier universe currently includes 36 economies.

Emerging Markets have confronted a number of shocks since 2020. This includes the pandemic, the increase in food/energy prices, along with a move higher in global interest rates. For frontiers, which are smaller economies, this has resulted in higher yields and more limited access to dollar-denominated funding.

Recent global challenges raise the question: What is the case for investing in frontier economies? Three are salient. First, among the 36 countries in the space, there is diversification potential. Second, there is plenty of differentiation among the sovereigns. Last and most importantly, since inception, frontiers have significantly outperformed the broader dollar-pay EM bond indices (proxied by the JP Morgan EMB-Global).

A comparison between the JP Morgan EMB-Global Index and the NEXGEM Index substantiates this point. The NEXGEM Index proxies frontier sovereign performance; it currently includes 33 of the 36 countries in our frontier universe. During 2023 the NEXGEM Index rose by 21 per cent, nearly 1,000 basis points better than the EMB-Global. This outperformance continued through the first half of 2024, with the NEXGEM returning +4.8 per cent vs +1.8 per cent for EMB-Global.

In terms of the macro trends in frontier economies, growth is higher for the group, which would be expected as they are starting from a smaller base. Turning to monetary policy, the news on inflation is less encouraging; it is higher, and food has a larger weight in the CPI baskets.

For investors, the willingness and ability of a sovereign to pay is the foremost concern. It is important to analyse the fiscal and external balance sheets across frontier economies and examine factors that determine payment capacity.

Our investment process entails evaluating whether country fundamentals are improving or deteriorating. In frontier markets, this has translated into an overweight position in the countries where we have a positive outlook on the countries’ fundamentals.

Too Risky?

The concern among investors is whether it is too risky to invest in frontier markets. Reflecting this concern, in December 2023, nine frontiers were trading at spreads 900 basis points above US Treasuries (we remove Lebanon from our market calculations). Excluding the sovereigns already in default, that left five countries in “distressed” territory.

Most of the economies that have defaulted are smaller and therefore have not had a systemic impact on the asset class. Together, the seven frontier markets that defaulted since 2020 account for just 1.4 per cent of EM GDP (using the EMBI ex-China as our universe). Second, after the shocks of the last four years, the weakest countries have already experienced payment difficulty. Colloquially, many of the weakest hands have folded.

With defaults tapering off, there was a strong rally in frontier sovereign debt in 2023. For context, while the NEXGEM Index returned 21 per cent last year, countries that were rated CCC or in default returned 50 per cent. Dividing this performance into two different categories, there are frontiers that many investors, going into 2023, expected to face payment stress. When this did not occur, these countries rallied strongly (El Salvador and Pakistan). The other group of countries was those that already defaulted. The investment thesis was that these sovereigns were prepared to settle with their creditors on terms better than initially feared.  This has borne out in Suriname, Zambia, and most recently Sri Lanka.

This highlights another relevant point. For most countries, the relationship with their creditors does not end after a restructuring. Countries typically renegotiate the terms of their debt and continue to engage with creditors as they restructure. Unlike some of the examples in the corporate universe, the net present value (NPV) on restructured sovereign debt has averaged about 50 cents on the dollar during the 1998-2022 period. Friendly restructurings can have an NPV over 75 cents on the dollar.

Diversification

Frontier debt investing allows for exposures to countries that can’t easily be found in other asset classes. This is not limited to dollar-denominated debt, as investing in frontier local markets also presents dynamic opportunities. Because frontier markets are smaller, they tend to be driven more by internal market dynamics.

This has two implications. First, local currencies in these economies are less correlated with other EM currency markets. Second, because these markets are not as saturated by international investors, macro considerations can be more important than global drivers. To be sure, in such markets, the potential for higher returns can come at the cost of less liquidity.

Differentiation

Looking at frontier economies as a group presents a unique set of challenges because this group of countries is so disparate. All are high-yield rated, though, we argue that not all can be painted with the same brush.

Some of the frontiers are ‘BB’ rated economies; within our universe of 36 countries, 14 are rated ‘BB-’ or higher by at least one rating agency. These countries are less vulnerable to event risk and have solid credit metrics. Examples of countries in this category include the Ivory Coast, Morocco, Paraguay, and Costa Rica.

On the other end of the spectrum, there are ‘B’ and ‘CCC’ rated credits, which could, in an adverse case, suffer from creditworthiness concerns. We saw some of these countries fall into distress post-pandemic. There are many countries between these two extremes—in some, credit fundamentals may not be rock solid, but there is not currently a high risk of default; examples would be Jordan, Nigeria, and Angola.

Our active positioning in frontiers has typically been above their share of the NEXGEM benchmark, but where we see a challenging outlook, we will take zero exposure. For context, within the NEXGEM universe described earlier, accounts that we manage only have exposure in 19 of the 33 countries. In short, we believe this market sector presents significant investment opportunities to those prepared to undertake in depth analysis of individual countries.

Although my team has been developing systematic fixed income approaches since 2001, only lately have we seen exponential growth in these types of strategies.

Barclays research estimates that USD90 billion to USD140 billion of capital is being managed in systematic credit vehicles and their popularity has exploded over the last two years. 

Systematic investing is far from new to equities. In 1973, Tom Loeb, who I had the fortune of working with at Mellon Capital Management, launched the first equity index strategy to make use of quantitative factors.

But things really took off in the 1990s. Nobel-winning economist Eugene Fama published his highly influential three-factor model.

At the same time, the end of the Cold War meant that mathematicians and scientists were less able to find employment in the defence sector, instead turning to a booming Wall Street. The phrase “quant” entered the financial lexicon and factor-based investing became increasingly common in equities into the 2000s.

But during this time, bond markets remained old fashioned by comparison. Even today, a lot of trading is done one bond at a time.

Worse, this type of trading became less liquid in the post-2008 regulatory environment. In high yield bonds, it can take days or even weeks to find the other side of a trade, with transaction costs of 50 basis points (bp) to 70bp on good days or north of 300bp in stressed markets.

Liquidity is a clear limitation of traditional passive and active strategies. In the US high yield market for example, our analysis of the eVestment database shows that most passive strategies only tend to hold 60 per cent of the 2000 bonds in the broad US high yield index, and active strategies generally hold 15 to 30 per cent.  

As a solution, we pioneered ‘credit portfolio trading’ over a decade ago, aiming to unlock hidden liquidity within the fixed income ETF ecosystem. We find we can bring US high yield transaction costs down to 10bp to 20bp while trading as much as USD500 million daily, with execution times from minutes to hours, even for less traded and traditionally illiquid bonds. It makes investing in 90 per cent or more of an index entirely realistic.

Another limitation of traditional strategies is the analytical burden. Fundamental active managers rely on credit analysts to avoid defaults and implement active positions. But with over 900 unique issuers in the US high yield market alone, even the most well-resourced credit teams can only cover a fraction of them. It generally means managers take relatively few alpha positions, while keeping them conservative because of the enhanced impact a default would have.

However, a systematic approach can automate credit analysis. Models are tireless, fast and repeatable, so analysing an entire bond universe is no big deal. Instead of a few, concentrated positions, a portfolio can implement numerous ‘micro’ active positions or tilts across its portfolio when seeking alpha.

Of course, any model needs to be well calibrated with a sufficient quality of data. The good news is that credit models are not new, albeit infamously difficult to practically implement. For example, Robert Merton’s Merton model, designed to pinpoint a company’s default risk, was published in 1974. However, the model needs tweaking for use in the real world, so due diligence on managers implementing these processes is essential.

We expect systematic fixed income strategies to continue to grow in popularity. However, investors need to work with those with proven credentials, experience and track record of applying systematic investing to fixed income.

Systematic fixed income investing is not a panacea, but it offers clear advantages in some asset classes, particularly areas that are less liquid, such as high yield.

Systematic approaches can perhaps also offer compelling diversification against traditionally managed strategies. For example, we find that 72 per cent of fundamental active high yield strategies have an alpha correlation of 0.5 or above with the average manager (limiting the potential benefits of manager diversification). Our strategy, by contrast has had an alpha correlation of less than 0.25 with 90 per cent of the fundamental active US high yield manager universe – based on our analysis the eVestment US high yield fund universe from April 2013 to March 2023 – and a negative correlation with 60 per cent of it.

If you have not already, it is time to think about how systematic fixed income might help you better address the challenges you face, and potentially be delivering more reliable returns and enhanced liquidity.

Don’t miss out on the digital revolution in bonds.  

ETH and BTC are the tokens used to pay transaction fees and to reward those running blockchain software.  BTC is referred to as an inflation hedge or digital gold. ETH could be digital oil, fuel that enables Digital Apps (dApps).  Ethereum dApps enable tokenisation, financial infrastructure, games and even social media networks.  Applications also enable Ethereum’s use as a backbone for blockchains known as Layer 2s.  These are designed around specific requirements such as speed, then use Ethereum as a secure, settlement layer between chains and institutions.

The market capitalisation of cryptocurrencies has grown over the last five years, however they are still volatile.  Bitcoin can be considered digital gold… for the brave.  Physical gold still has substantially lower volatility.  Despite the differences in the blockchains, they are still highly correlated in terms of price. Changes in BTC price currently drive the crypto market as a whole. 

Issuance of new tokens is one area of difference and is defined in the software of each blockchain rather than by committees.  Bitcoin issues a fixed number of BTC “rewards” every block paid to “miners” operating the network.  Initially 50 BTC per block, the software enforces a 50 per cent reduction every 210,000 blocks (~4 years).   From July 2024, the reward was 3.125 BTC and will halve again in 2028.

Ethereum requires “Validators” to provide an ETH “Stake”. Rewards are issued in proportion to the stake.  Ethereum also removes a portion of transaction fees from circulation.  Block rewards increase new ETH, transactions remove ETH from circulation.  Since 2022 the supply of ETH has reduced by 335k ETH. 

Validators running the Ethereum software earn rewards (~3.071 per cent) however this is complex and has created a new industry where technical service providers run the software on behalf of holders in return for a small percentage of the rewards.  This provides an opportunity for all ETH holders to earn yield.

Longer term, staking maybe a differentiator between ETH ETFs.  The US issuers initially had this as part of their products but for now, it has been removed.

There are big differences in energy usage across blockchains.  Ethereum relies on the Validators ETH Stake as a security guarantee, but bitcoin Miners can only process transactions if they commit computation to the network.  Computation makes it expensive for a malicious actor to disrupt the network.  For both blockchains, a substantial economic investment is needed by the Software Operators. With Ethereum, the investment is ETH, with bitcoin it is in computation which requires energy.

Gold does not need new functionality in order for it to be considered valuable.  Many bitcoin developers believe the same – bitcoin does one thing well and no more, but that is the point.   In contrast, Ethereum has a roadmap with releases introducing new functionality every six months.

The success and adoption of blockchains is driven by the software ecosystem.  An annual report published by Electric Capital found over 16,000 Ethereum developers, more than any other Blockchain by a very large margin.  Bitcoin was found to have only 1,853 developers.

Accounts holding more than USD100 have grown across both blockchains with a sharp uptick in recent months.  Ethereum transactions are steadily growing and account for around four times that of bitcoin.  If Ethereum “Layer 2” blockchains are included, the transaction count is far higher and growing.

As the growth and adoption of cryptocurrencies continues, we are seeing governments around the world take a wide spectrum of regulatory actions.  El Salvador became the first country to adopt bitcoin as a legal tender; they have since been followed by other countries.  In contrast, cryptocurrencies are subject to different types of bans.  As the assets become more widely adopted and understood, hopefully regulation will follow.

A more mundane risk is the displacement of ETH and BTC as the dominant cryptocurrencies. Given how embedded bitcoin is in the public consciousness, this maybe more of an issue for Ethereum.  However, Ethereum is well established as a platform for dApps and has by far the largest ecosystem.  This combined with the nature of software enables Ethereum to include the best innovations found in competing platforms.

Cryptocurrencies are software and so there is always the risk of defects.  There are however mechanisms in place to reduce this risk, for example Ethereum is run using multiple versions of the software developed by different teams.

On the surface bitcoin and Ether are very similar assets currently with a high degree of price correlation.  There are however distinct differences that may, in the longer term, cause a divergence in their price.  Ethereum has the potential for a big increase in adoption across a wide variety of sectors whilst the narrative around bitcoin as a store of value and hedge against inflation is growing.   Diversification across both assets maybe the best strategy.

However, nature and its ecosystem services are the most valuable asset class on the planet. The services that nature provides to our planet, such as flood protection, drought reduction, water purification, crop pollination, and carbon sequestration, are worth an estimated USD140 trillion annually globally, which is nearly one and a half times greater than global GDP.

Did you know in the UK, your home is more likely to be flooded than burgled? Nature is business-critical infrastructure. The whole economy is highly dependent on nature. We can all see the increasing cost of nature-related risks, like flooding or drought, on businesses. Still, because we don’t value nature as we should, we don’t see it as part of the solution.

We have neglected to maintain and upgrade our nature-based infrastructure, which has depleted 70 per cent of all wildlife globally. However, investing in nature and paying for its ecosystem services is the most efficient way to solve the climate and biodiversity crises, drive a thriving nature-based economy and create a world worth living in.

Though we are at a crisis point, we can reverse the damage. This isn’t about philanthropy; nature means business, and investing in nature still creates economic growth.

Our big idea is to redirect the flow of capital to protect and restore nature at scale. Nature provides invaluable ecosystem services, increases business resilience, and reduces nature and climate risks. Still, despite understanding its importance, we’re not valuing it. So, how do we transition to a nature-based economy, one where Nature is valued, making it possible for businesses to invest in and pay for nature for the first time? We need to start thinking about nature as an asset.

Nature as an asset

An asset has one or more of the following three characteristics: cash flow, utility, and scarcity value – and we haven’t conceptualised nature in this way before. Using seagrass as an example, we can relate to nature as an asset.

Seagrass meadows have substantial cash flow potential for the local communities and businesses, starting with breeding and feeding grounds for numerous juvenile fish species, including bass, plaice, and pollock, which have commercial value if fished sustainably.

Seagrass is in decline globally due to human impacts threatening the loss of these free services. Once plentiful in UK coastal waters, these meadows are now diminishing alarmingly. Seagrass meadows shrank by over 90% from around 80,000 to 8,000 hectares. As they disappear, their importance and scarcity surge in value.

In addition to providing biodiversity which can be fished sustainably, seagrass captures carbon, cleans the water and helps mitigate flood and protect the shore from erosion. Further, when you have seagrass, you get key stone species back like the seahorse. These utilities need to be paid for.

Our solution is to highlight five key problems that exist for companies here in the UK, caused and increased by climate change and nature loss – Flooding, Drought, Water Quality, Biodiversity and Carbon – and work to solve these issues, by demonstrating the significant benefits companies get for paying for nature’s services to improve their resilience. This payment, paid for by the companies who benefit via ‘Nature as a Service’ (NaaS) offtake agreements, which creates a financial return for the investor, which makes nature an investable asset class.

Getting companies to pay for nature via NaaS offtake agreements generates cashflow making it an asset with tangible value, which encourages us to take care of it. This is where we stop destroying nature and start restoring it.

We aim to build a portfolio of long-term NaaS contracts from a diverse group of companies, combined with creating biodiversity units and, carbon credits, that we believe will deliver an 8 to 12 per cent return to our investors, whilst adapting to and mitigating climate change and nature loss.

The UK’s nature deficit requires an estimated GBP50 to 100 billion over the next 10 years, and we see long term asset owners, like pension funds as instrumental in bridging the finance gap. A 2 per cent allocation from the UK pension industry to invest in nature could generate the necessary funds to redirect the flow of capital, making our ambition a reality.

By taking this approach, we will reduce risks for companies, create a financial return for pension funds, and create a UK worth living in.

The only problem is that a stronger JPY and higher interest rates directly impede the BOJ’s efforts to break for good from Japan’s decade-long disinflationary vicious cycle; price stability is, after all, the BOJ’s primary mandate.

For investors’ positioning in the Japanese markets, it is essential to understand how this ‘conflict’ between the MOF and the BOJ eventually plays out.

Yen is cheap by any measure

The Yen looks cheap based on any fundamental metrics. For example, according to the Real Effective Exchange Rate (REER), as of May 13 2024, the Japanese currency is at the cheapest level since at least 1989.

In addition, USDJPY seems to have diverged from short-term portfolio flow metrics, like interest rate differentials. For example, the divergence started already appearing at the beginning of April 2024 but became particularly pronounced after the BOJ intervention in early May.

Finally, at the end of April, USDJPY reached overbought levels not seen since December 2001. These were some of the technical reasons why the MOF eventually instructed the BOJ to intervene and buy JPY in the open market. 

However, in our opinion, the MOF has other more structural reasons for wanting to see the Japanese currency stable, at the minimum. Facing exceptionally low returns on capital at home, thanks to the ultra-low rate policy the BOJ pursued to inflate the economy and meagre prospects for equity capital appreciation, Japanese private capital has chosen to invest abroad.

This private capital exodus abroad seems to have been a clear trend in the last two decades. The shocking part is that the MOF & BOJ intervention in the Autumn of 2022 did not seem to have affected this capital flight trend at all. 

A cheaper currency can help a country improve its external imbalance or revive its economy, thus potentially pushing its inflation rate higher. A trend of constant currency depreciation can pretty much do the opposite – wreck a country’s economy by undermining trust in its institutional and governance frameworks. It is likely that Japanese government officials at the MOF may fear that the currency depreciation trend would hit such a point of no return unless something is done to promptly stem or potentially even reverse it. 

Kishida meets Ueda

The BOJ, on the other hand, does not seem to have such concerns. For more than two decades, policymakers at the Central Bank have unsuccessfully tried to achieve their main mandate of price stability by getting the Japanese economy out of the spectre of disinflation. 

And then, in the early 2020s, we had the confluence of the Covid crisis and geopolitical tensions disrupting global supply chains and providing the structural base for a shift in the low inflationary period globally from which Japan also naturally started to benefit. 

Moreover, the Japanese currency started to weaken, fuelling the fire of Japanese inflation. This is ‘manna from heaven’ for the BOJ – a Japanese Central Bank Governor could realistically fulfil his primary mandate for the first time. BOJ governor Ueda is not going to let that slide, is he?

In early May, there seemed to have been a ‘routine’ meeting between PM Kishida and BOJ Governor Ueda. What was not routine, however, was that after the meeting, the governor’s tone concerning the currency’s effect on inflation suddenly changed. Only 11 days before, Ueda had said that “the yen’s recent fall did not have an immediate impact on trend inflation”; after the meeting with the PM, the governor said that the “BOJ may take monetary policy action if the yen falls affect prices significantly”. 

Currency impact

The MOF ultimately controls the currency and only instructs the central bank to transact on its behalf. As such, policymakers have already shown their card. Anyone who knows or has dealt with Japanese officials knows that once they have embarked on a project, they will keep going at it until it is complete or they have run out of options, sometimes, even if only out of ‘pure pride’. 

The BOJ is reluctant to raise rates, as that goes against its mandate. However, a central bank is never fully independent from the government, and there is inevitably some pressure on the BOJ to be more hawkish. Therefore, if a hawkish BOJ does not stem JPY weakness, then the MOF/BOJ will embark on another round of intervention. 

Empirical literature shows that unilateral foreign exchange intervention seldom works, though, to be fair, most of the studies are done for emerging market countries with limited FX reserves. Japan not only has a sizeable official stock of USDs, but it can also harness, in theory, the private stock of USDs. 

Moreover, it can quickly get a swap line from the Fed, with the intervention effectively becoming dual, and the chance of success increases substantially. So, Japan has options and still an opportunity to stem the weakness of its currency.

What about rates?

The BOJ can sound hawkish, but we suspect it will stick to its initial assessment of postponing raising rates as long as possible so as not to jeopardise its inflation mandate. 

The worst possible outcome remains one of accelerated inflation, with or without JPY weakness, which becomes ingrained and pushes inflation expectations in the opposite vicious cycle to what Japan experienced before (so higher, not lower). With the stock of debt multiple times its GDP, to combat this rise in inflation, Japan will find itself trapped, unable to raise rates sufficiently fast for fear of triggering a vicious debt cycle instead. 

Suppose the inflation cycle globally has turned on the back of shifting global supply chains, advanced manufacturing, AI, green energy capital investments, and geopolitical tensions. In that case, Japan will not be the only country facing the choice of a vicious inflation cycle on the one hand and crippling debt payments on the other. 

However, while in the preceding three decades it was emerging market countries that had to face that predicament, in the years to follow, it would be mostly developed countries because they are the ones that have substantially increased their debt stock. Japan may be the first one that the markets would force to act.

As one of the leading Indian venture capital firms, we would make the following points to global investors looking at India, without getting into party political analysis.

Firstly and fundamentally, India’s economic prospects remain extremely robust. India is on track to become the third largest economy in the world by 2030. It is expected by the IMF to be the fastest growing major economy in the world this year at 6.8 per cent, and to continue at 6.5 per cent in 2025.

This growth is being powered by compelling long-term trends. India’s working age population to population ratio will be the highest of any largest economy by the end of this decade, and consumer spending is set to double in size in the same period.

Even better, India’s growth is digital-led. Between 2018 and 2023 the number of internet users in the country increased from 398 million to 907 million, growing from 29 per cent of the total population to 64 per cent. There are now nearly a billion mobile phone users in India, more than two-thirds of the total population.

Secondly, one of the best ways to access India’s highly attractive growth is via investing in startups.

India now has the third largest startup ecosystem in the world. There was a period of extraordinary growth between 2020 and 2022, when the number of unicorns trebled to over 100 and the number of startups increased by over 50 per cent to 57,000 with a combined valuation of over USD450 billion.

The picture became more complex in 2023 which was a difficult year for a number of reasons including a global economic slowdown and post-Covid market corrections. There was a sharp decline in deal volume and fundraising, which fell 50 per cent overall.

Now, however, there are clear indicators that growth is returning. The number of startups in India rose from 57,000 to 68,000 last year. The number of unicorns has also continued to grow, to 115, with 112 “soonicorns” in the pipeline.

Thirdly, the Indian government has been very supportive of the Indian startup ecosystem and this is very likely to continue.

Previous initiatives include the Fund of Funds for Startups (FFS) scheme, the Startup India Seed Fund Scheme (SISFS), and the Credit Guarantee Scheme for Startups (CGSS). These were implemented under the Startup India initiative to provide capital at various stages of a startup’s business cycle. The government also previously announced several new measures including tax concessions for startups and customs duty exemptions for EV-related capital goods and machinery.

Fourthly, there are other strong factors which could drive future growth. Last year, it was reported that Indian investors have lined up about USD20 billion in dry powder–capital waiting to be deployed in startups. India retained its position as the second-largest destination for venture capital and growth funding in the Asia Pacific region.

The exits that VC funds were able to secure in 2023 in India amounted to USD3.46 billion across 79 deals. That number is likely to rise significantly in the years to come as the Indian startup ecosystem resumes its growth trajectory.

Fifthly and finally, this positive outlook is further supported by the growing focus on high-innovation sectors such as BioTech, Speciality Chemicals, HealthTech, and DeepTech. All of this is being driven by venture capital investment and demonstrates the growing maturity and sophistication of the VC industry in India.

The result of these positive tailwinds for the Indian startup ecosystem is that there is likely to be increased international investment deployed into the space via Indian VC funds as global allocators increasingly recognise the highly attractive opportunities available.

These investors will be likely to recognise that they cannot allocate capital without having the right partner on the ground that can guide them through the complexities and nuances of the Indian market. Indian VC funds that can demonstrate both a strong track record and a distinctive investment philosophy and that have sophisticated international quality operational infrastructure will be best-placed to be those partners.