Japanese corporate funds not eating the home cooking

Almost a year into Japan's “Abenomics” experiment, Japanese corporate pension funds' cool stance toward their country's resurgent domestic stock market is becoming an increasingly lonely — if long-term — one.

The country's public pension funds, with combined assets of $2 trillion, are expected to get marching orders next month to take on more risk, while market veterans report a growing number of overseas investors adding Japanese equities to their portfolios this year as well.

Even Mrs. Watanabe — the symbolic Japanese retail investor, with the bulk of her savings stashed safely in the bank — is showing signs of being lured back to the market by tax incentives pushed through by Prime Minister Shinzo Abe's government this year.

That pickup in interest reflects this year's more than 40% gain for key benchmark stock indexes — inspired by the promises of radical steps to revive Japan's long-dormant economy which swept Mr. Abe to power last December.

At the start of that rally, opportunistic foreign players led the charge. More recently, however, longer-term investors have been joining in.

Hedge funds “pushed up the market” at first, but “more and more, pure institutional clients are putting money into Japanese equities now,” said Alex Sato, Tokyo-based CEO of Invesco Japan.

A recognition that, for the first time in a long time, underweighting Japanese equities can hurt performance has prompted a growing number of RFPs from big overseas investors this year, including sovereign wealth funds in Asia, Scandinavia and other parts of Europe, market veterans say.

Among them, the insurance arm of Korea Post, which set an October timeline for picking money management firms to invest 60 billion won ($57 million) in Japanese equities. Lee Maeng-Ho, a Seoul-based assistant director with the Korea Post Insurance Bureau, couldn't be reached for information regarding which managers had been selected.

Japanese corporate pension funds — with a combined $800 billion in retirement assets for big defined benefit plans and multiemployer plans covering small and midsize firms — have remained wallflowers at that equity party.

Those corporate funds have sold into the rally, with the average allocation to domestic equities dropping to 16% of total portfolio assets at the end of March, from 34% roughly a decade before, noted Toru Kubota, a Tokyo-based senior investment consultant with Towers Watson & Co., at a recent conference in Singapore.

After years of sitting on unrealized losses on their holdings of Japanese stocks, many corporate pension funds have used this year's rebound as a good opportunity to take profits, said Invesco's Mr. Sato.

For a big chunk of the roughly $300 billion in retirement assets for multiemployer plans, a government-mandated restructuring program is contributing to that “risk-off” stance.

By government decree, multiemployer funds that don't meet specified funding levels will be merged into the $1.21 trillion Government Pension Investment Fund over the next five to 10 years. As a result, many of those roughly 500 funds — which according to Tokyo-based investment consulting firm Rating and Investment Information Inc. had an average domestic equity allocation of 21.7%, topping the 14.1% average for big corporate DB plans — are trimming risk now from portfolios to bring them in line with the GPIF's more conservative asset allocation mix.

(That gap might become easier to bridge after November, when a panel advising Prime Minister Abe is expected to recommend the GPIF and other big public funds shift from portfolios dominated by Japanese government bonds in the direction of a more endowment-like approaches to asset allocation.)

For the roughly $500 billion in corporate defined benefit plan money, the road to a more “risk-on” asset allocation approach could be a long one, market veterans said.

Money managers and consultants note that two decades of capital market misery have left corporate pension funds effectively institutionalizing a “risk-off” stance.

Against the backdrop of deflation and the Japanese stock market's long downtrend, corporate pension plans have slashed their targeted annual returns to as low as 1.5% now from more than 5% a decade ago — a goal that pretty much rules out the need for heavy allocations to equities, noted Invesco's Mr. Sato.

After years marked by a spate of sharp drawdowns in the value of their pension assets, many companies have opted to shoulder the heavier pension contributions a conservative investment strategy demands as less disruptive to their business plans than their previous, more aggressive investment approaches proved, said Akihiko Ohwa, former manager of the IBM Japan Pension Fund who now serves as an instructor at Waseda University Graduate School.

Japanese corporate pension funds remain focused on lower volatility assets — seemingly “happy to contribute to fill funding gaps rather than to invest into higher return assets,” agreed Christoph Hofmann, global head of distribution with emerging markets debt boutique Ashmore Group PLC, London. “As such, the Japanese pension market continues to be a fixed-income market and its appetite for equity risk assets seems pretty limited.”

Many observers say the new bounce in the Japanese economy's step under Mr. Abe would have to persist for a considerable period of time to change the mind sets of corporate pension executives.

A combination of heavy unfunded pension obligations and core business losses has left a number of Japan's biggest companies leery of taking a lot of pension-related risk, noted Koji Ezura, Tokyo-based head of institutional sales with Nikko Asset Management Co. Ltd. Only when their core businesses recover are they likely to allocate more to riskier growth assets, he said.

Big Japanese corporations “have lost confidence in their own future,” agreed Noriyuki Morimoto, a veteran investment consultant who founded Tokyo-based HC Asset Management 11 years ago.

Corporate executives need to become confident again about the future of the Japanese economy before they'll be willing to manage corporate pension assets more aggressively, Mr. Morimoto said. One year of Abenomics has provided a lift, but nothing dramatic enough to wrench Japan's broader pension management industry out of its “risk-off” mindset, he said.

Some see the ongoing move away from equity as a one-way street.

If the economy — and interest rates — rebound, reducing pension liabilities, corporate pensions are likelier to pursue liability-driven investment strategies than increase risk again, predicted Kohji Ushijima, head of institutional sales with Allianz Global Investors Japan in Tokyo.

For now, said Mr. Ushijima, efforts to address risk are almost entirely focused on fixed income — with moves out of “no return, high risk” Japanese government bonds into segments such as multiassets, bank loans, short duration high yield, and unconstrained bond strategies.

According to Robert White, the Singapore-based president of Eaton Vance Management International (Asia) Pte., there's been a dramatic pickup for bank loan strategies from Japanese corporate pension funds. A few dozen mandates have accounted for roughly half of the $900 million in bank loan inflows Eaton Vance has garnered in Japan year to date.

Ryo Ohira, a Tokyo-based managing director with Neuberger Berman Group LLC and head of the firm's business in Japan and Korea, said his firm is likewise seeing demand for bank loans now, but after that market segment's strong run in recent years, there is also interest in multiasset strategies investing in other fixed-income segments as well, such as high yield bonds.