Japan panel eyes shift to riskier assets for GPIF

A panel of experts advising Prime Minister Shinzo Abe's government has set Japan's $1.2 trillion Government Pension Investment Fund on course for riskier waters, with potential rewards for the Japanese economy and managers of active investment strategies.

But the Tokyo-based fund's size could prove an obstacle to implementing the panel's call to ditch the GPIF's focus on Japanese government bonds for an approach to asset allocation and portfolio management more in line with top public pension funds around the world.

The panel's Nov. 20 final report said the GPIF's 60% allocation to ultra-low-yielding Japanese government bonds — defensible in the deflationary environment of the past decade — should not be maintained in the inflationary one Mr. Abe has promised as a centerpiece of his quest to revive Japan's economy.

The seven-member panel, led by Tokyo University Professor Takatoshi Ito, urged the GPIF and other big public funds in Japan to diversify into real estate investment trusts, real estate, infrastructure, venture capital, private equity and commodities, while shifting more assets to active strategies from passive and adopting a more dynamic approach to asset allocation.

Governance of those public funds, with combined assets of roughly $2 trillion, should be strengthened by making them more independent of the ministries that oversee them.

Likewise, a willingness to pay for top-flight investment talent — whether to build internal capabilities or better manage risk — should replace the current minimalist approach to staffing and manager fees, the report said.

Some observers — noting that previous calls for reform had come to naught — urged caution.

The recommendations make sense, but the challenges of revamping investments at a fund controlling such a large chunk of Japanese retirement savings will be considerable, warned Alex Sato, president and CEO of Tokyo-based Invesco Asset Management (Japan) Ltd.

Even so, many money management executives seem ready to accentuate the positive.

The pace of reforms remains an open question, but the direction will clearly support the growth of Japan's pension and money management industries, said Ryo Ohira, a managing director and head of East Asia with Tokyo-based Neuberger Berman East Asia Ltd.

A number of issues remain, however, including the question of how the world's biggest public pension fund — for which a 5% allocation would amount to $60 billion — can effectively add allocations to capacity-constrained market segments.

In a telephone interview, panel member Sadayuki Horie, Tokyo-based senior researcher at Nomura Research Institute's financial technology and market research department, conceded that the GPIF's size will pose a challenge to pursuing the panel's portfolio management recommendations.

But with the Ministry of Health, Labor and Welfare, which oversees the GPIF, strongly opposed to breaking the pension fund into more maneuverable pieces, the panel instead settled on the idea of setting aside a small portion of the fund — in the neighborhood of $100 billion — as a “baby fund,” possibly focused on the GPIF's forays into alternative investments, Mr. Horie said.

The GPIF's size will inevitably be a major issue in the future, but an initial baby fund should provide a foundation to build on in dealing with the problem, said panel member Masaaki Kanno, managing director, economic research with Tokyo-based J.P. Morgan Securities Japan Co. Depending on the outcome, more baby funds could be added later, he noted.

Yasuhiro Yonezawa, a professor in Waseda University's Graduate School of Finance, Accounting and Law in Tokyo who also served on the panel, argued that the baby fund proposal was aimed more at managing risk efficiently than as a solution to the problem of the pension fund's size.

In a telephone interview, Tokihiko Shimizu, the Tokyo-based director-general of the GPIF's research department, noted that the panel's proposal has left it to the government and the GPIF to fill in the bulk of the details regarding what a baby fund should be and how it should operate.

While the GPIF will await the ministry's guidelines on how to proceed, it has already done feasibility studies on capacity-constrained asset classes, and any efforts in that regard would, of necessity, have to be made in a very gradual, deliberate manner, said Mr. Shimizu.

A spokesman for the pension division at the Ministry of Health, Labor and Welfare said the panel's recommendations will be carefully studied.

REITs would be a natural first step in the GPIF's push into alternatives, Mr. Yonezawa said. Subsequent steps could be worth the wait, some alternative asset managers reckon.

Junichiro Kawamura, Tokyo-based senior vice president with Swiss private markets asset manager Partners Group AG, said even if the GPIF's initial alternatives allocations start off small and grow gradually, the resulting potential in Japan for increased institutional interest in asset segments such as private equity and infrastructure should prove “very exciting.”

While it could take roughly a year to craft legislation implementing such recommendations as the change to the GPIF's governance structure, the pension fund's current asset allocation framework — which permits allocations to range from five to eight percentage points on either side of asset class targets — would allow for considerable shifts over the near term.

As of June 30, the GPIF's Japanese government bond allocation was just below its 60% target, with room to range within eight percentage points on either side of that target.

Domestic equity, at 15.7%, was above the 12% policy target, but still within the permitted range of six points on either side; international equity, at 12.9%, was just above its 12% target, and the international bond allocation, at 10%, was below its 11% target.

In a Nov. 20 research note, Mr. Kanno predicted the GPIF would be permitted enough flexibility to allow allocations to yen bonds to drop to 50% by the summer of 2014.

The Bank of Japan's recent policy initiative to flood the market with liquidity, meanwhile, could set the stage for a seamless transfer of that huge amount of Japanese government bonds, Mr. Kanno said.

Eventually, Japanese government bonds should drop to between 30% and 40% of the GPIF's portfolio — higher than the 20% to 30% range typical of leading public pension funds abroad to account for Japan's rapidly aging demographic profile, Mr. Kanno said. Meanwhile, another ¥30 trillion ($300 billion), or a quarter of the fund's assets, should eventually shift into “risk assets,” according to the J.P. Morgan report.

In the panel's discussions, Nomura's Mr. Horie said he proposed separating a “cashout” portion of the GPIF, which is already experiencing net redemptions, from a remainder to be managed with a long-term perspective.

That cashout portion could be ¥30 trillion or more, leaving an amount for long-term investments which, at ¥50 trillion to ¥70 trillion yen, would be more in line with the top end of existing sovereign wealth funds, such as Norway's, he said. The GPIF is proceeding along those lines, Mr. Horie said.

Still, the changes in the GPIF's governance structure could be the panel's most important recommendation for the long-term management of Japan's public pension money, Mr. Horie said.

Market veterans said the panel's recommendation that the GPIF consider non-market-cap-weighted benchmark indexes, such as the recently launched return-on-equity-focused JPX-Nikkei 400 index, is another move that could have favorable implications for Japan's economy.

J.P. Morgan's Mr. Kanno said the GPIF's adoption of the JPX-Nikkei 400 could prompt Japanese corporations with $2 trillion of cash on their balance sheets to put that money to more effective use, such as boosting dividends or pursuing share buybacks. That would effectively make the pension fund the first “professional institutional investor in Japan” with the power to exert a material influence on the efficiency of Japan's corporate sector, he said.

Still, some money managers say patience will be needed.

“A lot of opportunities are coming,” but they will likely emerge gradually and only after the time required to put a new governance structure in place and enhance risk management, said Junji Kawahara, a Tokyo-based director of consultant relations with BlackRock Japan Co. Ltd.

Others see tangible benefits coming sooner.

“Risk budgeting, new benchmark decisions and the weight of potential money moving from (Japanese government bonds) will have a significant influence on the yen and Japan's equity market, noted John Alkire, Tokyo-based CEO of Dimensional Japan Ltd.

Meanwhile, the GPIF's policy decisions should influence a range of other actors, beginning with fellow public pension funds, corporate pension funds and even individual investors, Mr. Alkire said, adding, “I see this as a real and positive development” that should prove meaningful even with a traditional “make haste slowly” approach.