TOKYO -- Japan is about to create a Y150 trillion ($1.39 trillion) gorilla. The question is whether the Parliament will let the gorilla out of its cage.
Next April, Japan's Ministry of Health and Welfare will launch one of the world's largest institutional investors, the Pension Funds Investment Fund, which eventually will be responsible for managing the nation's vast pool of public pension assets. The system is a cross-generational transfer system roughly equivalent in how it operates to the U.S. Social Security system.
Initially starting at Y40 trillion, the new entity is expected to grow to Y150 trillion in 2008, creating a potential bonanza for money managers worldwide.
The problem is the fund will have its hands tied unless ministers decide to shed the requirement that public pension funds invest most of their 70% to 80% bond allocation in zaito loans -- essentially a secondary budget that finances Japanese infrastructure needs.
For at least seven years starting in 2001, the public pension funds, together with Japan's postal savings system, will continue to finance zaito programs started in prior years, and will continue to buy new zaito bonds issued during that period.
Even after the seven-year stretch is up, the new fund will continue to purchase zaito bonds if it sees them as a good investment opportunity, said Hiroyuki Mitsuishi, deputy director of the Health and Welfare Ministry's Pension Bureau's office for investment guidance.
That policy has critics seething. "Personally, I just cannot see much meaning in the scheduled change to the public pension funds' investment system," said Tetsuro Taira, a senior consultant at the Nikko Research Center's Institute of Pension Research.
"Even after a system change, a large portion of the public pension funds will continue to be used to finance the zaito loan programs," added Mr. Taira.
How it works
Under the current system, the Ministry of Health and Welfare makes annual pension contributions to the Trust Fund Bureau, which is overseen by the Ministry of Finance, headed by Kiichi Miyazawa. Those contributions are used to finance the government's zaito loan programs. The Trust Fund Bureau repays each chunk of money over a seven-year period plus interest of 1.8% or 1.9%.
Under the new system, repayments of Y110 trillion in outstanding zaito loans will be channeled directly into the new pension fund over the next seven years.
The current system has its drawbacks. Not only are pension assets used to finance infrastructure projects, but additional assets are funneled from the Trust Fund Bureau to the Pension Welfare Service Public Corp., which in turn makes low-interest home loans to plan participants, and runs recreational facilities.
But the corporation also must pay the Trust Fund Bureau about 3.8% in annual interest on the zaito loans. That creates pressure to generate sufficient returns -- not easy while this quasi-governmental body has been chalking up a cumulative investment loss of about Y1.4 trillion since 1986, even though it turned a profit in 1999 -- the first time in nine years.
Nearly Y22 trillion, or 89%, of the Pension Welfare Service Public Corp.'s assets are managed by external managers, including: Sumitomo Trust & Banking, which runs Y632 billion; Mitsubishi Trust & Banking, Y589 billion; and Yasuda Trust & Banking, Y435 billion, all in balanced accounts. U.S. managers also have a piece of the action: Goldman Sachs Asset Management runs Y275 billion in Japanese equities, while State Street Trust and Banking runs Y305 billion in international stocks.
Asset allocation plan
Some experts would like the new fund to be a more aggressive investor, making substantial equity investments.
But those pleas have fallen on deaf ears to date. During Diet deliberations on pension reform last year, former Health and Welfare Minister Yuya Niwa said the new fund's asset mix should be at least 70% to 80% in domestic bonds, plus 10% domestic equities and 10% foreign equities.
And that's unlikely to change for the foreseeable future.
"Those who contribute to the public pension plans do not wish the government to look into alternative investments for higher returns," Mr. Mitsuishi said. "If that's what the public wants, we must drastically review the basic portfolio plan again. But at least during the Diet deliberation on the pension system reforms, nobody voiced such an opinion. Rather, all Diet members sought for the safest and surest way to manage and invest the public pension assets."
He added that government officials are confident they can meet their 4% assumed rate of return with a high bond allocation, but would change the asset mix if the investment environment changed drastically.
The Pension Funds Investment Fund will invest part of its bond holdings, including the zaito bonds, on its own.
But a large portion of the assets, including all of the equities, will be outsourced to external managers. Ministry officials have not decided how much of the assets will be outsourced nor under what timetable.
Initial asset management
Initially, the new fund's assets will top Y40 trillion, including Y15.5 trillion from the Trust Fund Bureau; and Y24 trillion in assets held by the Pension Welfare Service Public Corp. which will be abolished when the new fund is launched. Additional assets will come from new contributions, which have not been set yet.
Most of the Trust Fund Bureau's Y15.5 trillion, however, are expected to be used to purchase zaito bonds, alleviating a drain on assets as individual savers cash out low-yielding postal-savings system deposits.
That would leave less than Y30 trillion -- though still substantial -- that could flow into stocks and bonds. To avoid any market shocks, the new pension fund will not sell any of the Pension Welfare Service Public Corp.'s Y8 trillion in domestic equities.
Ministry officials plan to allow stock holdings to slip to around 10% of assets as the fund grows during its seven-year transition period. However, officials plan to name a study group shortly to devise draft guidelines on investment strategy and asset allocation.
Managers for the new fund will face intense scrutiny, Mr. Mitsuishi said. Money managers' performance may be disclosed on the Internet, and any shortfalls stemming from negligence or malicious intent will be punished, he added.
"If the asset management plan goes well, pension fund assets will grow, reducing the amount of required contributions to the pension fund. But if it fares badly, taxpayers might be called on to offset any losses," said Nikko's Mr. Taira. Under the current plan, it is still unclear where the ultimate responsibility lies if investment losses materialize.
"Eventually the system will be set up so that nobody will be held responsible if investments fare badly," Mr. Taira predicted. "They just wait, hoping that the market will recover and eventually offset the investment losses."