GPIF ready to make big investment move

The world's largest pension fund could begin bulking up on riskier assets later this year, even as many other big asset owners struggle to find pockets of value in capital markets buoyed by quantitative easing.

The anticipated shift by Japan's US$1.3 trillion Government Pension Investment Fund, Tokyo, from domestic government bonds to Japanese and global equities, global bonds and alternatives could prove the biggest on record by a single fund, exceeding $200 billion by some estimates.

The change would be in line with last November's recommendation by a government advisory panel that GPIF ditch a conservative asset allocation, anchored on a 60% weighting in domestic bonds, in favor of one that's more in line with big, sophisticated funds around the globe.

Its other targets are 12% each for Japanese and foreign stocks, 11% for foreign bonds and 5% for cash.

Its actual allocation, according to reported results for the quarter ended Dec. 31, was roughly 55% domestic bonds, 17% domestic equities, 15% foreign equities, 11% foreign bonds and 2% cash.

The timing for a big move out along the risk curve might not be ideal.

Market veterans say years of extraordinary monetary policy stimulus following the global financial crisis have elevated valuations for a range of asset classes, including global equities, real estate and infrastructure.

With equity markets and other risk assets rebounding strongly in recent years, finding opportunities capable of delivering similar returns going forward is getting “harder and harder,” Matt Whineray, chief investment officer of the NZ$25.5 billion (US$22.1 billion) New Zealand Superannuation Fund, Auckland, said in a May 12 interview.

It's not time to get defensive, but against the backdrop of low volatility and plentiful liquidity, “the real difficulty (now) is that sort of asset allocation decision,” he said.

If it's a tricky moment for asset allocators, then the GPIF — tapped by Prime Minister Shinzo Abe to play a supporting role in his plans to revive Japan's economy — could be facing a governance test if its quantum leap into higher-risk assets comes at a pricey entry point.

The GPIF's move into riskier assets isn't self-directed — it's a result of government pressure, said a veteran Tokyo-based investment consultant who declined to be named.

If “Abe-nomics” ultimately works, the move into risky assets will appear consistent with the GPIF's fiduciary duties. But the fund could face a backlash should a less friendly market environment ensue, said the consultant.

In a June 20 interview, Yasuhiro Yonezawa, the Waseda University finance professor tapped earlier this year to head the GPIF's investment committee, said when new asset allocation targets are decided this fall, transitioning the portfolio likely will be gradual.

Observers expect the GPIF's targeted allocations to Japanese stocks, global stocks, global bonds and alternatives to rise at the expense of domestic bonds, which could drop to 40% from 60%.

Reducing the domestic bond exposure is easy compared to deciding where to redeploy the money, said Mr. Yonezawa, adding the government would probably prefer to see as much of that money as possible allocated to Japanese stocks. And arguments in favor of local stocks can be made now in terms of valuations, as well as improvements in governance and return on equity, he said.

Shan Lan, a Hong Kong-based equity strategist with Deutsche Bank, said the GPIF could invest an additional US$50 billion to US$100 billion in Japanese equities if the fund's domestic stock target rises — as some predict — to 20%, plus or minus six percentage points, from 12%.

Mr. Yonezawa said his committee won't necessarily share the government's focus on local stocks, relying instead on risk-return data to determine the best mix among domestic stocks, foreign stocks and global bonds.

When asked about alternative investments, he said it would be a challenge to find segments with enough capacity to make a difference for a fund where a one percentage point allocation amounts to $13 billion.

Earlier this year, the GPIF made initial forays in infrastructure and Japan real estate investment trusts. Mr. Yonezawa predicted the GPIF will invest more in infrastructure because it is capable of absorbing sizable allocations. He said private equity, global REITs and direct real estate investments are areas under review.

On the governance front, Mr. Yonezawa said the fund will be restructured over the next year or two as a more independent entity with a board of trustees. Now, GPIF President Takahiro Mitani has decision-making authority, while reporting to the minister of health, labor and welfare.

A number of market veterans said they see no reason to be overly pessimistic about the GPIF's prospects for making a successful transition to a higher-risk, higher-return portfolio.

“Rebalancing a portfolio is always a risky move, and some of the low-hanging fruits are already picked,” said Tai Hui, global market strategist, Asia, with J.P. Morgan Asset Management in Hong Kong.

But with U.S. and Japanese stocks supported by earnings growth, emerging market equity valuations more interesting after recent declines, and other pockets of value, it should still be possible to generate “a respectable return,” Mr. Hui said.

As for Japanese stocks, at 13 times prospective earnings, valuations are “very, very cheap” now, said Tomohiro Okawa, stock market strategist with UBS AG, Tokyo. After pulling back earlier this year from the Tokyo market's torrid gains in 2013, foreign investors have begun coming back, he said. That's true for both shorter-term players, such as hedge funds, and longer-term investors, he said.

John Vail, Tokyo-based chief global strategist with Nikko Asset Management, said conservative options, such as focusing on overseas equities offering high dividend yields — which he termed a dividends-at-a-reasonable-price strategy — remain a compelling opportunity.

In any case, should Mr. Abe succeed in reigniting a degree of inflation in Japan, the GPIF's heavy bond allocation will itself become a high-risk strategy.

“It's a relative value game,” and the outlook for allocations to overseas stocks and bonds has to be compared to the risks of maintaining a huge domestic bond portfolio that could suddenly be facing losses should inflation return, noted Ryo Ohira, managing director and head of Tokyo-based Neuberger Berman East Asia Ltd.

In that sense, if the GPIF's entry point for certain risk assets is a little bit high now, its “exit point” from Japanese government bonds might likewise prove high — relative to how the value of the bonds will fare should inflation pick up further, said Nobusuke Tamaki, a professor at Otsuma Women's University, Tokyo, and a former director general of the GPIF's planning department.

If so, the GPIF's shift to a higher-risk, higher-return asset allocation could prove to be a case of “not terribly bad timing,” Mr. Tamaki said.

Meanwhile, if overseas flows, resulting from higher allocations to global stocks and bonds, contribute to a further strengthening of the dollar against the yen, that could support the value of the GPIF's overseas portfolio even if global stock prices sag a bit, said Mr. Ohira.