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October 19, 2015 01:00 AM

Money managers seeing big bonanza from Japan

Firms hoping to profit from huge allocation shift

Douglas Appell
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    Alex Over said the big Japanese funds are beginning to 'internationalize' fixed income.

    Global bond managers say Japan is looming ever larger on their radar screens as the country's largest public funds shift allocations away from Japanese government bonds and show a greater willingness to pay for performance.

    Japan's big public funds are taking significant steps now to globalize their investment portfolios, including early moves “to internationalize their fixed-income exposure,” said Alex Over, managing director, global sales and product strategy with Boston-based Standish Mellon Asset Management LLC.

    The country's largest pension fund — the ¥141 trillion ($1.17 trillion) Government Pension Investment Fund — has led the way, but “a number of other pension funds are at various stages of following their lead,” seeking better risk-adjusted returns than the Japanese government bond (JGB)-heavy portfolios they're rebalancing out of now, said Mr. Over in an interview.

    If the GPIF's global bond mix of 70% passive and 30% active strategies becomes the template, big public funds would need well over $10 billion in additional allocations to active managers to reach the higher risk-higher reward asset mixes they adopted over the past year.

    Big winner's circle

    Meanwhile, in a potential sign of increasing sophistication, the winner's circle for recently awarded mandates has broadened considerably to include less familiar names in the region, such as London-based Colchester Global Investors Ltd., Denver-based Janus Capital Management LLC and New York-based Fischer Francis Trees & Watts Inc.

    The pickup in opportunities follows the GPIF's adoption 12 months ago of sharply higher allocation targets for riskier assets in anticipation of the return of inflation that Japan's government has pledged to sustain.

    Early this year, three other public funds — the ¥21 trillion Pension Fund Association for Local Government Officials, or Chikyoren; the ¥7.8 trillion Federation of National Public Service Personnel Mutual Aid Associations, or KKR; and the ¥4.2 trillion Promotion and Mutual Aid Corporation for Private Schools of Japan, or Shigaku Kyosai — adopted the same targets: 35% for JGBs, 15% for international bonds and 25% apiece for domestic and international equities.

    Tokyo-based GPIF's previous targets were 60% JGBs, 12% each domestic and international equities, 11% international bonds and 5% cash.

    Manager search activity by public funds in Japan has been active since last year, led by GPIF and Chikyoren, said Kohji Ushijima, Tokyo-based head of institutional sales with Allianz Global Investors Japan, in an e-mail.

    On Aug. 31, Chikyoren announced it hired 11 active bond managers, including household names such as Goldman Sachs Asset Management and Prudential Investment Management, but smaller bond players as well, such as Colchester, Janus and Pictet Asset Management.

    A Chikyoren spokesman declined to say what portion of the fund's $20 billion in global bond allocations as of March 31, was actively managed.

    On Oct. 1, GPIF, the world's largest pension fund, announced it had hired 21 active bond managers to oversee roughly ¥5.5 trillion, an average of roughly $2.2 billion per manager. The list included heavyweights such as GSAM, Prudential and New York-based BlackRock Inc., but also Colchester, Janus, MacKay Shields, FFTW and Standish Mellon.

    In a sign of more to come, on Sept. 28, Tokyo-based KKR announced a search for active foreign bond managers. Previously, that public pension fund had managed all of its foreign bond exposure passively, noted Mr. Ushijima.

    With only 2.7% of KKR's $65 billion portfolio in global bonds as of the fund's March 31 fiscal year close, its board's decision in February to boost its targeted allocation to 15% from 4% left the fund roughly $8 billion short of that goal. A KKR spokesman declined to say what portion of that total would be actively managed.

    And even larger pools of money are in play now. Around the same time the GPIF began moving, Japan Post — with an investment portfolio of more than ¥200 trillion — began hiring more global bond managers as well, money management executives said.

    Japan Post data show foreign bonds rising to 9.8% of the bank's portfolio from 7.8% over the 12 months through June 30 - an increase of almost $40 billion, combined, to passive and active strategies. Over the same period, JGBs tumbled to 49.2% from 60.2%.

    Money management executives said underlying trends pushing Japanese pension money into global bonds should remain in place.

    Japan's aging population has “a clear need to get income on their assets, so the move to yield investments is likely to continue for some time,” predicted Jim McCaughan, the New York-based CEO of Principal Global Investors.

    Mr. McCaughan said Principal Global's focus on strategies offering that yield have helped make Japan his firm's strongest market in Asia. Principal Global, with $341 billion in assets under management as of Sept. 30, has seen the assets its fixed-income affiliate manages for Japanese clients jump to $8.2 billion as of June 30, from $266 million three years before.

    On Oct. 15, meanwhile, TCW Group became the latest global bond shop to open a Tokyo office, to better position the firm to grow its business providing “income-oriented” fixed-income strategies to Japanese investors,” a news release from the Los Angeles-based manager said.

    If global managers have taken heart from a rise over the past year of close to $10 billion in the GPIF's allocations to actively managed global bonds, the fund's latest compensation arrangements with its managers have likewise caught their attention.

    What's interesting is that the GPIF allocations included a performance component — a clear indication that the fund is looking for managers to deliver excess returns above the benchmark, said Mr. Over.

    A GPIF spokesman said in an e-mail, “the performance fees we have adopted” - the first time compensation for all GPIF managers for a major asset class will include such fees - “are for the purpose of (providing) more incentive to our active managers.” The spokesman declined to provide specific details about the new fee arrangements.

    Performance fees for long-only strategies have been rare in Japan, but market veterans predict that might change with the precedent set by the GPIF - a “trend setter” for the asset owner community, noted Mr. Over.

    In the past, managers, speaking strictly on background, described GPIF allocations as being more valuable for the cachet they would provide than for the extremely low fees they yield — although with allocations far larger than those awarded by other asset owners, many said some discount was only to be expected.

    The GPIF spokesman said for the fiscal year ended March 31, his fund paid ¥7.5 billion to active managers overseeing 5.48 trillion yen in global bond allocations — an average fee of roughly 13.6 basis points.

    Well below average

    Taeko Sumiyoshi, Tokyo-based managing director with Greenwich Associates Japan K.K., said her firm's latest research showed the average fee paid to active international bond managers by 20 public funds surveyed in Japan, ex-GPIF, came to 35 basis points, well below the average 43-basis-point fee paid by 275 corporate pension funds surveyed.

    Public pension funds are increasingly turning to performance fees for traditional asset classes, “mainly to reduce the fixed costs” when managers are underperforming, said Allianz's Mr. Ushijima.

    Moreover, the upside for outperformance is limited to ensure managers are not rewarded for taking outsized risks, managers say. The GPIF spokesman confirmed the fee arrangement has both “a ceiling and a floor.” n

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