Mizuno says fund's competitive strength best employed by boosting market returns via ESG, better alignment with managers, corporate governance
The world's biggest pension fund is focusing on beta, but not in a passive way.
Hiromichi Mizuno, chief investment officer of Japan's ¥156.8 trillion ($1.4 trillion) Government Pension Investment Fund, in a Nov. 13 interview said the business model he's put in place at GPIF over the past three years revolves around leveraging the fund's weight in financial markets to improve beta.
As a "textbook" example of a "universal owner" whose scale basically requires it to own the market, GPIF must "pay more attention to the system, because we — particularly — are a system owner," said Mr. Mizuno. "We can't beat the market and we don't have to beat other asset owners. We are not in a competition."
Instead, "we're more interested" in enhancing beta — through a focus on areas such as corporate governance, environmental, social and governance factors and achieving better alignment of interests with external managers — than expending time and resources on eking out benchmark-beating gains, Mr. Mizuno added.
That doesn't mean active managers have no role in managing GPIF assets. But, he said, it's the "systemic" role active managers play in creating the market efficiencies that which make passive strategies work that the fund is looking to support.
"Particularly for the Japanese market, I feel responsible to promote active management, because we are the biggest owner" of passively managed Japanese equities, said Mr. Mizuno. GPIF's latest annual report showed just less than 10% of its ¥35.2 trillion domestic equity allocation in actively managed strategies as of March 31.
A number of the initiatives Mr. Mizuno cited — from his team's efforts to promote more long-term decision-making by asset owners, asset managers and listed companies to recent moves to support leading asset managers overseas in setting up shop in Tokyo — are aimed at systemic improvements that wouldn't typically be on an asset owner's to-do list.
With his private equity background as a partner at London-based Coller Capital Ltd., Mr. Mizuno said his first task upon being appointed GPIF's chief investment officer three years ago was to "analyze what business model GPIF should pursue."
His review of asset owners around the world pointed to three basic models — big organizations, including top Canadian pension funds, looking now to bring all investment activities in-house; somewhat smaller asset owners, such as U.S. state pension funds, with a mix of in-house and externally managed assets; and — what he termed "category C" — the large number of smaller organizations outsourcing 100% of their assets.
With a regulatory framework that requires the fund to outsource all assets, the Canadian model was not an option for the GPIF.
Instead, Mr. Mizuno said he and his team concluded the GPIF can be a sort of "super-category C-type of asset owner," outsourcing everything but "compared to our peers in that category" whose small scale gives them zero leverage, "we actually have enough weight to have a serious dialogue with asset managers."
"That observation is the foundation of what I've been trying to achieve at GPIF ever since," said Mr. Mizuno.
"We're guaranteed to be the biggest customer" for the money management industry, and that status carries responsibility to take a leadership role in the way asset owners work with money managers, he said. Broadly speaking, the efforts GPIF is making in that regard amount to shifting the focus of leadership "from short term to long term, and from alpha to beta," he said.
Mr. Mizuno said GPIF's work with asset managers has focused on how managers themselves are governed. Improvement in their corporate governance is a prerequisite both for their ability to hold the companies they invest in to higher standards as well as for GPIF's ability to award them more money, he said.
Low active allocation
Even as Mr. Mizuno acknowledged the systemic benefits active managers provide for passively managed strategies, GPIF data for its latest fiscal year ended March 31 showed the fund's lowest allocation to active managers in more than a decade.
The 9.3% actively managed share of the pension giant's domestic equity allocations was down sharply from 17% the year before — reflecting the reclassification of more than ¥3 trillion of smart-beta strategies as passive rather than active — and even further below the 22% to 25% share that prevailed between 2007 and 2012.
Mr. Mizuno said achieving the alignment of interests with managers that could pave the way for a rebound in allocations to actively managed strategies remains a work in progress. There's been considerable improvement on some fronts, such as the response of managers at home and abroad to GPIF's calls for more independent directors on their boards, but more is needed, he said.
GPIF's latest annual report showed the fund's active equity managers as a group delivered little if any alpha over the past five to 10 years. Against that backdrop, Mr. Mizuno expressed little sympathy for active managers seeking higher fees. "I know we pay very little ... but how can we pay higher when active managers as a group, net of fees, made almost zero alpha?"
"We have zero interest in reducing the absolute fee level" and would be happy to pay more if they perform, but the current investment model doesn't "allow me to increase" allocations to active managers, Mr. Mizuno said.
Mr. Mizuno said his team's discussions with managers revolve around the structure of fee arrangements rather than the level of fees. "First, we need to be comfortable that we (have) alignment of interests with the asset managers," and then GPIF can analyze whether there are managers worth awarding mandates to, he said.
He noted the fee structure changes GPIF is exploring have been considered by other high-profile public funds, such as the California Public Employees' Retirement System and California State Teachers' Retirement System, but ultimately not pursued — largely because those funds had an option to bring investments in-house.
"We don't have the in-house option, so we are totally committed to make these things happen, to create a win-win relationship," he said.
Money management executives in Tokyo, who declined to be named, said discussions with GPIF on new fee structures could result in changes in the near future. One senior executive said whether GPIF moves to cap potential performance fees could be decisive in determining how enthusiastic managers will be in embracing those new arrangements.
Mr. Mizuno said progress needs to be made on a number of fronts to allow asset managers and asset owners alike to adopt a long-term mindset. For asset owners' part, the CIO reiterated his belief that announcing quarterly updates is counterproductive, sending the wrong message both to fund stakeholders as well as to their external managers.
While GPIF's investment team works to smooth the portfolio's volatility ("we are investment professionals ... not philosophers"), Mr. Mizuno said he pays "zero attention to quarterly results."
Reinforcing the message
GPIF's focus on ESG issues is likewise a tool to reinforce that long-term message, said Mr. Mizuno.
"When we tell (asset managers) we want you guys to integrate ESG into your investment decisions, it will force them to think long term, because they're all long-term factors, said Mr. Mizuno.
The fund allocated an initial 3% chunk of its domestic equity allocations to ESG-focused indexes earlier this year, and GPIF President Norihiro Takahashi suggested that could grow to 10%.
But Mr. Mizuno said the signal that allocation is sending to the market is more important than its size — with expectations that a broad-based takeup of ESG investing will make such indexes irrelevant at some point.
In asking the providers of the three ESG indexes the fund selected to publicly disclose their rating methodologies, the GPIF addressed another issue that should help listed companies provide more uniform disclosures.
That request effectively moves ESG from a "Michelin guidebook model," where restaurants don't know when a reviewer will visit or how they are reviewed," to a "Zagat model," where everybody knows exactly what they're rated for, Mr. Mizuno said.