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June 25, 2001 01:00 AM

WESTERN IDEAS: Risk budgeting, indexing catch on in Japan

Currency overlay, alternatives also taking hold as regulation loosens

Phyllis Feinberg
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    TOKYO - Japanese pension fund officials, particularly those from large companies, are being influenced by ideas brought to them by Western money managers.

    Broad ideas such as risk management and risk budgeting, as well as specific strategies such as indexing, currency overlay and alternative investments all are being explored by many, and adopted by some, Japanese pension plans.

    "Pension plan sponsors need to be enlightened; they need to catch up to global trends," said Yasuteru K. Aizawa, president of the International Pension & Economic Research Institute, a Tokyo-based organization working for Japanese pension reform.

    "Up until now the Japanese pension plan market was very protected," he said. "Now with a rapid wave of deregulation, pension funds can show more individuality. They have to get the fund management style best suited for their own needs."

    The Pension Fund Association, Tokyo, recently published a report that tried to "introduce the methodology of risk management to all employee pension funds," according to a senior consultant from Frank Russell Japan Co. Ltd.

    "Risk management is thought of as a very important mission for pension funds in Japan," the consultant said, adding "risk budgeting, which was recently introduced, is the latest method which plan sponsors can use to decide the magnitude of risk that can be tolerated in advance."

    Looking at downside

    Risk management involves monitoring and controlling the risk of an entire investment portfolio. Risk budgeting involves assigning a risk allotment to individual investments in a portfolio.

    Goldman Sachs Asset Management Japan Ltd. has a strategic advisory relationship with Honda Motor Co., Tokyo, in which the firm uses risk-management strategies to advise the Honda pension fund on asset allocation. Makoto Takano, executive officer and general manager of institutional marketing at GSAM in Tokyo, said, "80% of performance is generated from the asset allocation decision."

    "We have recommended the client diversify more globally and recommended that it hedge currency risk to some extent, according to their risk tolerance," said Mr. Takano.

    State Street Global Advisors (Japan) Co. Ltd. also is advising its clients on risk-management strategies and using tactical asset allocation, particularly currency overlay.

    Eric Michel, who was president and representative director of State Street Global Advisors (Japan) and was promoted earlier this month to senior vice president, head of investment management at State Street Cos. Japan said, "Handling currency risk at the central level gives you more opportunity to do investments overseas. The investment is limited by the risk of the currency."

    SSgA now runs more than $4 billion in currency overlay strategies for Japanese pension funds.

    Private equity, hedge funds

    Western managers also are bringing private equity and hedge fund investments to their Japanese pension fund clients.

    "Private equity helps in diversifying alphas from active investments and in diversifying equity exposures," said GSAM's Mr. Takano. He said three of the 50 largest Japanese pension funds are clients of GSAM's hedge funds.

    And earlier this year, SSgA launched a Japanese market-neutral fund, according to Mr Michel. This is an on-shore private placement fund.

    Masao Tamura, a certified pension actuary in the funds analysis department at the Nomura Funds Research and Technologies Co. Ltd., said his organization holds monthly study meetings to explain alternative investments to pension fund managers. "It will take time before most jump into the pool," he said.

    Of the 500 to 600 pension fund managers in Tokyo, about 150 attend his organization's seminars on alternative investments, he said. "But this doesn't mean they will get into them right away."

    One of those that is already investing in alternatives is Nippon Steel Corp., Tokyo. Nippon Steel's Y360 billion ($295 million) pension fund has 3% of its assets in alternative investments, including a hedge fund of funds and securitized real estate. It uses Japanese advisers for its hedge funds, said Shozo Tokuzumi, executive adviser to the pension fund.

    Hitachi Investment Management Ltd., which manages the Y2 trillion pension fund of Hitachi Inc., has 5% of its assets in alternative investments, said Hiroshi Maruta, president and chief executive officer of Hitachi Investment. Hitachi has some investments in foreign equity partnerships and some investments in Japanese real estate.

    Indexed core catching on

    One strategy that has been popular among U.S. pension funds for years - an indexed core portfolio with specialist mandates surrounding it - received a push recently in Japan from the Y150 trillion Government Pension Investment Fund, which covers all workers in Japan except for public employees.

    Noboru Terada, executive investment officer of the GPIF, formerly was the head of the Japan Pension Fund Association and is a strong believer in indexing. Currently, about half of the GPIF's assets are indexed, but Mr. Terada plans to increase that to 80%. He plans to hire more index fund managers and specialist managers who will actively manage stock and bond portfolios around the indexed portion (Pensions & Investments, May 28).

    Mr. Terada's prominence in the Japanese pension fund industry means any change to his fund's management could have a big impact on other pension fund managers in Japan.

    Not surprisingly, SSgA, one of the largest indexers in the United States, is promoting index funds in Japan.

    "There is a growing trend in the Japanese pension market to have passive management as the core of the fund with active alternative investments as satellites around the core," said Mr. Michel.

    "Many pension funds consider index funds as an important tool of risk management, for example to be used for the rebalancing of assets or in an active/passive strategy," said the consultant from Frank Russell.

    75% in index funds

    SSgA has Y2.2 trillion under management in Japan, with 75% of the amount in index funds. The firm reports that 3.3% of the total is indexed to passive Japanese equity benchmarks and the remaining 71.7% is indexed to Morgan Stanley Capital International indexes.

    Barclays Global Investors, San Francisco, the other U.S. indexing giant, has been promoting indexing in Japan for several years through its joint venture with Nikko Securities Inc., and now has Y3 trillion under management in indexed strategies in Japan. The firm's assets "come predominantly from Japanese pension funds, both public and private," said Francis Enderle, chief investment officer for indexing in the United States, who spent 12 years in Japan for BGI. The firm manages money for the GPIF and also for the Pension Fund Association.

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