Japan's Government Pension Investment Fund has set course to steer its ¥127.3 trillion (US$1.11 trillion) portfolio into more volatile waters, in search of higher returns.
Upgrading the fund's ability to manage that elevated risk will be key to determining how turbulent the ride will be.
That effort is underway, even as debate on reforming the GPIF's governance structure — focused on giving the fund greater autonomy from Japan's Ministry of Health, Labor and Welfare — looks set to extend through the end of the year or beyond, observers say.
GPIF is building the capabilities needed to “tilt our portfolio” away from the fund's policy asset mix when it's highly confident it can add alpha by doing so, said Tokihiko Shimizu, the Tokyo-based director general of the fund's research department, in an e-mail.
The fund is moving now to hire professionals who can expand those capabilities, he said.
But much remains to be done to put in place the systems and the professional firepower needed to transition the world's biggest pension fund from a relatively sleepy, bond-heavy portfolio to one that will face both higher expectations and greater scrutiny as its returns are increasingly driven by equity market volatility.
On Oct. 31, the GPIF announced it had boosted its equity target allocation to 50% of the fund's portfolio — split evenly between domestic and international stocks — from 24%, while slashing its target for domestic bonds to 35% from 60%.
The target for international bonds, the GPIF's fourth and final asset segment, was raised to 15% from 11%, while a previous 5% weighting to cash was eliminated.
Other announced changes included setting a 5% ceiling for the fund's initial foray into alternatives, and endorsing a tactical approach to asset allocation.
Establishing multiple layers of risk management, in place of the simpler approaches used in the past, “will be absolutely crucial to the GPIF,” said Sadayuki Horie, the Nomura Research Institute Ltd. executive serving as the GPIF's deputy chairman and head of the fund's policy asset allocation subcommittee, in a Nov. 4 interview.
With market benchmarks such as the U.S.'s S&P 500 index hovering near historic highs, the current moment may not be an especially auspicious one to begin shifting roughly US$100 billion to international shares and US$86 billion to Japanese shares. The fund's most recent announcement of its portfolio weightings as of June 30 showed allocations of 17.3% to domestic equity and 16% to international shares.
But if downside risks make the current moment a challenging one for repositioning the portfolio, standing still wasn't an option, contended Mr. Horie.
In March, the definition of risk for the GPIF shifted to not being able to keep pace with the real wage growth that determines the growth of the fund's liabilities, from not being able to match the returns of a portfolio of domestic bonds.
With the government's actuarial analysis anticipating real returns on domestic bond holdings over the next 25 years to be either an annualized -0.2% in its base case upside economic scenario or -0.1% in its base case downside scenario and wage increases of an annualized 1.7%, there was an obvious need to invest in higher-return assets and equities were “the only choice,” said Mr. Horie.
If the GPIF is on course to significantly boost its holdings of risk assets, it's also preparing to bolster its ability to analyze and adjust its exposures in response to changing market conditions.
The fund's explicit adoption of a tactical approach to asset allocation came with a widening of the “permissible range of deviation” from the targets for its three biggest asset segments: to 10 percentage points from eight points on either side of the 35% target for domestic bonds; to nine points from six points on either side of the 25% target for domestic stocks; and to eight points from five points for its target of 25% for international stocks.
“We don't want to bet tactically” on the basis of short-term forecasts, said Mr. Horie. However, if the GPIF concludes there've been changes to the long-term horizon, they can make tactical changes, he added.
But the fund has to expand its capabilities in areas such as risk management and long-term forecasting to make that possible, he said, adding “we cannot do (tactical asset allocation) right now.”
In other areas aimed at mitigating risk, the Oct. 31 road map, in a first for the GPIF, cited alternatives as a means of attaining greater efficiency through diversification.
To GPIF's credit, it didn't set aside a specific category for alternative investments, noted Charles Millard, the New York-based head of pension relations at Citigroup Inc., in an e-mail. Instead, the fund's announcement stated that “alternative investments will have to fit in their respective classifications as domestic or international stocks or bonds, depending on the profile of return and risk,” he said.
A 5% allocation has proven to be a “starting point” for a number of pension plans, he noted.
GPIF executives conceded that, at between $55 billion and $60 billion, it could prove challenging for the fund to make that initial 5% allocation to alternatives. But if successful, that ceiling could be raised after five years or so, they said.
With the investment template set, attention will turn to a study group tasked with reviewing the GPIF's governance structure. The group is expected to make recommendations that could make the GPIF more independent of the government.
Among more controversial topics, some observers say the study group should debate whether to allow the GPIF to bring some equity investments in-house — something not possible under current rules.