Ongoing transition to credit from JGBs might not be big boon for managers
Japan Post Bank will continue to shift trillions of yen from Japanese government bonds to offshore credit, but the Tokyo-based giant's next round of mandates might yield lower fees for money managers.
Meanwhile, the next important allocation change for the bank's ¥207.8 trillion ($1.82 trillion) portfolio will be a steady, deliberate move into alternatives, the firm's investment chief said.
Katsunori Sago, the ex-Goldman Sachs Group (GS) Inc. executive who took the helm of Japan Post Bank's investment division in June 2015, said in an interview the bank's “biggest allocation change” — its move into mostly U.S. credit from JGBs, which began before he arrived — is likely “to continue ... given the current JGB yield level.”
In Tokyo trading on March 17, the benchmark 10-year Japanese government bond was yielding just less than eight basis points.
The challenges that scant yields have posed for what JP Bank terms the JGB-heavy “base,” or liability-matching, segment of its portfolio, have led to faster-than-anticipated growth for its “satellite” portfolio of higher-yielding investments, dominated by foreign bonds.
The satellite portfolio reached ¥60 trillion by the end of 2015 — more than two years ahead of the March 2018 target set at the start of 2015 in the firm's medium-term management plan — and ¥68.8 trillion by the end of 2016.
Between March 31, 2015, and Dec. 31, 2016, Japanese government bonds dropped to ¥73.5 trillion, or 35.3% of JP Bank's investment portfolio, from ¥106.8 trillion, or 51.9%. Over the same period, the bank's externally managed foreign bond holdings more than doubled to ¥30.2 trillion, or 14.5% of the total, from ¥14 trillion, or 6.8%, while its internally managed foreign bonds holdings climbed to ¥21.2 trillion from ¥18.8 trillion.
That ¥16.2 trillion jump in foreign bond mandates, which equates to roughly $6.7 billion a month, has made JP Bank the institutional client of choice for bond managers the world over.
In recent years, having JP Bank as a client has been the key factor determining whether a manager's business in Japan has been growing or not, said one executive with a global firm managing money for the bank, who declined to be named.
Mr. Sago conceded that, with more than $250 billion already allocated to active credit managers, “we're going to reach some sort of limit at some point.” With about 30 active external managers, and a broad range of exposures to investment-grade, bank loans and high-yield bonds, the bank is effectively buying the market, and getting more beta than alpha for its efforts, he noted.
One response: Starting this month, JP Bank began investing in beta — or passive — credit strategies, at “much cheaper” fees, said Mr. Sago.
A JP Bank spokesman said new allocations will be a mix of active and passive mandates.
Some of the bank's active managers, speaking on condition of anonymity, said they see room for further hefty allocations but at lower fees than previous mandates.
Whether active or passive, Mr. Sago said the continued growth of the bank's investments in higher-yielding assets has made the use of the term “satellite” for those allocations somewhat outdated.
Taper off soon
Some industry analysts expect the growth of the satellite portfolio to taper off soon. Tetsuya Yamamoto, a Tokyo-based vice president and senior analyst with Moody's Investors Service, said growing constraints on bank capital as Japan Post Bank shifts allocations to assets with greater credit risk from JGBs should keep its satellite portfolio from growing much beyond ¥70 trillion.
Mr. Sago suggested there's still room to grow. He said the satellite portfolio wouldn't grow to half of the portfolio — a line in the investment sand that remains roughly ¥30 trillion away. The JP Bank spokesman said that doesn't mean the portfolio's higher-yielding assets would necessarily grow by another ¥30 trillion.
Mr. Sago said he figures he's more than two-thirds of the way to building an investment team at JP Bank that will prove equal to the challenge of optimizing the bank's total portfolio — a key to delivering for shareholders, after the former government-owned entity was privatized and listed on the Tokyo Stock Exchange in November 2015. JP Bank collects deposits from 24,000 post offices nationwide but remains heavily restricted in extending loans that would compete with other private banks.
Mr. Sago said his extensive financial sector ties — he left Goldman Sachs as deputy president after a 22-year career with the firm — have helped him bring 30 industry veterans to JP Bank since he joined, boosting the ranks of investment professionals there to 130.
One Tokyo-based executive recruiter, who declined to be named, said it's not an exaggeration to call Mr. Sago's hires — such as Kazunari Yaguchi, the deputy general manager of Development Bank of Japan's real estate department he brought in to head JP Bank's real estate investments, and Hideya Sadanaga, the global head of product development at Nissay Asset Management Corp. he tapped to lead the bank's private equity efforts — an “all-star team.”
The investment team is 70% complete, said Mr. Sago: “I want to complete the remaining 30% over the next 15 months or so,” at which point the portfolio won't be perfect but “we'll be in perfect shape to work on ... portfolio optimization.”
Mr. Sago said his team could complete its targeted shift in allocations over the coming 15 months, but only by compromising the quality of the portfolio — especially when it comes to the alternatives allocations JP Bank has begun adding over the past year or so.
'Started those investments'
The bank's plans call for allocating up to 3% of its portfolio, or $55 billion, to alternatives, and over the past 18 months, “we've started those investments” — to private equity, real estate and hedge funds — “one by one,” said Mr. Sago.
For now, however, the amount of money actually called, as opposed to committed, to alternative strategies comes to around $2 billion, or roughly 10 basis points of the portfolio — two-thirds of that total for hedge funds, he said.
There's no sense of urgency in deploying that capital. “Our plan is to spend another several years or so to complete the alternative portfolio construction because we want to only work with high-quality asset managers, and their capacity for new investment is limited,” said Mr. Sago.
In addition, JP Bank will look to diversify the timing of its investments, rather than making a flurry of large allocations at what could turn out to be the peak of the market, he said.
A deliberate strategy makes sense even if growing institutional allocations globally look set to weigh on private equity and real estate returns in coming years, he said.
“It's going to be more crowded going forward, so expected returns should be lower,” said Mr. Sago, adding “it is what it is.”
But the deviation from those mean returns should remain quite wide, raising the importance of identifying and working with top-tier managers, he said.
For JP Bank's broader portfolio, Mr. Sago said while he agrees with the view that, given the size of the bank's portfolio, “the difference we can make by doing active investments, or by being tactical ... is limited ... that doesn't mean we shouldn't try.”
Doing so can squeeze out an additional $1 billion or $2 billion in returns — small in relation to the size of JP Bank's portfolio, but big just the same in absolute terms, he said.
Mr. Sago said his investment team is capable of taking advantage of tactical opportunities and did “quite well” in making a considerable change to the risk profile following Donald Trump's victory. That involved lowering its dollar hedges in currency markets and using U.S. dollar swaps to reduce the U.S. dollar interest rate exposure of its foreign bond holdings. He declined to say exactly what the impact was.
This article originally appeared in the March 20, 2017 print issue as, "Japan Post Bank starts turn to alts".