Big Japanese fund may shift assets

Signs that Japanese regulators are seeking ways to boost returns of the country's huge public pension fund could eventually open new opportunities for foreign asset managers in areas such as absolute return and alternatives.

Executives with foreign and domestic managers alike said recommendations in May by Japan's Council on Economic and Fiscal Policy for managing the ¥150 trillion ($1.4 trillion) Government Pension Investment Fund, Tokyo, are early steps in a process that could see more of that fund's assets moved from low-yielding Japanese government bonds to actively managed and absolute-return strategies.

Foreign managers already have benefited in recent years from 2001 reforms that boosted the amount of Japanese pension assets outsourced to external managers.

According to Tokyo-based Nomura Research Institute Ltd.'s 2007 review of Japan's asset management sector, Barclays Global Investors, San Francisco, was the biggest asset gatherer over the four-year period ended March 31, 2007, garnering ¥11 trillion, followed by Boston-based State Street Global Advisors, with ¥5 trillion.

In third place was Nomura Asset Management, with ¥3.5 trillion, followed by three more foreign managers with between ¥2.5 trillion and ¥3.5 trillion in Japanese pension assets apiece: Pacific Investment Management Co., Newport Beach, Calif.; Morgan Stanley Asset Management, New York; and AllianceBernstein LP, New York. JPMorgan Asset Management, New York, and Fidelity Investments, Boston, also were among the top 10 asset gatherers. All seven foreign firms manage money for the GPIF.

The 80% of GPIF assets in passive strategies has benefited indexing giants BGI and SSgA, while other foreign players have attracted assets for their expertise in active foreign equities and bonds.

Average GPIF investment returns of roughly 3% a year over the past five years have met or exceeded the statutory target of 3.2%, but with a population profile that has left Japan's working-age population declining by hundreds of thousands of people every year, pressure to boost returns can only grow.

“There's definitely a feeling of change in the air” that could eventually lead to more assets being allocated to strategies with greater potential to generate alpha, said Paul Price, the Dublin-based global head of institutional business with Pioneer Investments.

Pioneer doesn't manage GPIF money now, but the company is making the long-term commitment to the Japanese market needed to earn the trust of the country's most sophisticated institutional investors, he said.

While a move into higher-return strategies could play further into the strengths of foreign managers, it won't happen quickly, market veterans warned.

With reports quickly emerging of key ministers opposing some of the council's proposed pension reforms, “we shouldn't anticipate any imminent government initiatives,” said Didier Devreese, Tokyo-based president of Schroder Investment Management (Japan) Ltd.

Still, small changes in Japan — especially for such a huge and influential pension fund — can be significant, market veterans said.

In Japan, this is “how things start,” said Doug Hodge, a Tokyo-based managing director of PIMCO's Asia-Pacific business, and a period of glacial movement can end up in a huge shift, like the reorganization of the country's public pension system that created some big opportunities for PIMCO and other foreign money managers.

That reform, in April 2001, set up the GPIF, which took over management of pension assets that had previously been used largely to fund government projects. Today, foreign managers look after roughly 30% of the ¥120 trillion of GPIF money invested in publicly traded securities.

But some analysts said the trends that powered healthy growth in pension fund assets for foreign managers over the past six or seven years might be coming to an end. Sadayuki Horie, a senior researcher with Nomura Research, said both the steady shift of pension assets from non-marketable securities to outsourced mandates for marketable securities over that time period, and the move from Japanese trust banks to foreign managers to look after foreign stock and bond mandates, have passed their peaks, possibly making further gains more difficult.

And any move toward alternatives will be very gradual. The very size of the GPIF makes it tough for executives there to allocate money to areas like hedge funds of funds in a way that would have a meaningful impact on the entire portfolio, while losses on new types of investments could be problematic for such a public entity, said the Tokyo head of another major foreign manager, who declined to be named.

Still, pressure to increase the fund's investment returns should keep the question of diversifying into areas such as hedge funds, private equity and real estate in play, said Koji Yamamoto, president and representative director of State Street Global Advisors (Japan) Co. Ltd., Tokyo, who predicted change could come over the next five to 10 years.

Managers and investment consultants alike praised the staff of GPIF for being transparent and unbiased when choosing between domestic and overseas managers.

The heavyweight fund is well known for being aggressive in negotiating low management fees — Nomura Research's Mr. Horie noted that the average fee on the 80% of GPIF assets in passive strategies and the 20% in active strategies is a mere three basis points — but the reputation boost of getting the fund's “seal of approval” is great, managers said.

Dev Clifford, a managing director with Greenwich, Conn.-based Greenwich Associates, said some managers have reported garnering a number of Japanese corporate pension mandates soon after the GPIF announced that is had hired their firm.

In the Japanese market, winning a mandate from the GPIF, with its size and transparency, is “very important,” agreed PIMCO's Mr. Hodge.

Contact Douglas Appell at [email protected]