GPIF's smart beta flows may portend foreign allocations

Japan's Government Pension Investment Fund doubled its allocations to domestic smart beta equity strategies last year, a vote of confidence that could point to mandates for foreign factor-based strategies when the ¥135 trillion ($1.3 trillion) behemoth reshuffles its overseas equities manager lineup later this year.

The GPIF's annual report for the fiscal year ended March 31, released July 29, showed the Tokyo-based pension giant's allocations to active strategies rising roughly 1 percentage point, or $13 billion, for each of the four major asset classes in its policy mix: domestic and foreign stocks and bonds.

For domestic stocks, however - where GPIF added its first smart beta strategies in March 2014 - the past year's entire ¥1.4 trillion rise in active allocations went to the fund's smart beta managers: New York-based Goldman Sachs Asset Management Co. and Tokyo-based Nomura Asset Management Co.

GSAM's strategy, benchmarked against the S&P Global Intrinsic Value index, and Nomura's Research Affiliates Fundamental index strategy are classified as active by the GPIF in the sense of moving away from traditional market-cap-weighted benchmarks, rather than being managed with the goal of adding alpha above their respective smart beta benchmarks.

Michael Sebastian, Singapore-based global chief investment officer of Aon Hewitt's delegated investments business, said factor-based strategies could prove a logical port of call for the world's biggest pools of capital.

With “investors of a certain size” constrained in their ability to add value through traditional skill- and security selection-based active management, “exploiting persistent market inefficiencies ... through broad rule-based strategies would be one of a limited number of ways” for those whales to potentially add value, he said.

For GPIF's latest fiscal year, GSAM's assets more than doubled to ¥1.6 trillion and Nomura's RAFI assets jumped 56% to ¥1.3 trillion, boosting the smart beta portion of GPIF's ¥5.653 trillion in total active domestic stock allocations to 50%, from 33.5% the year before.

Managers of foreign factor-based strategies could be next in line to benefit from the GPIF's growing appetite for smart beta.

At the April start of the new fiscal year, the fund embarked on a review of its current lineup of 13 managers overseeing $49 billion in overseas equities - entirely benchmarked, for now, against market-cap-weighted MSCI Inc. indexes.

As part of that process, GPIF will “adopt” smart beta managers of overseas equities if they have strategies “we evaluate highly,” said Shinichiro Mori, a Tokyo-based GPIF spokesman, in an e-mail.

It will be the first broad GPIF manager review since the fund, in April, launched a registration system and asked international equity managers to be the first to apply.

Under that system, managers will provide in-depth details about their organizations and the investment strategies they want to be considered, and then provide monthly performance updates that will leave GPIF better positioned to add or change managers, as needed.

Executives with foreign money management firms, who declined to be named, predicted GPIF could announce its overseas equity manager selections by year-end.

GPIF began reviewing applications on June 1, and the process could still take “more than several months,” said Mr. Mori.

The diversification and relative performance benefits smart beta strategies provided GPIF for the latest fiscal year - a period that saw global stock market volatility and a rising yen tag the fund's portfolio with a 3.8% investment loss - could count in their favor.

The 7.87% decline for GSAM's S&P GIVI strategy and Nomura RAFI's 9.47% drop helped limit the loss on GPIF's ¥5.7 trillion active domestic equity allocation to 9.9% for the latest fiscal year, less than the 10.95% loss for the more than 80% of the fund's ¥30.6 trillion in domestic equities that was passively managed.

It was the first time in five years that the fund's active allocations outperformed the TOPIX index of large-cap stocks listed on the Tokyo Stock Exchange - the benchmark for the bulk of GPIF's domestic stock exposure. For the latest fiscal year, the TOPIX index, after figuring in dividends, dropped 10.82%.

The GPIF “appreciates all the smart beta strategies from the viewpoint of diversification of risk factors,” noted Mr. Mori.

Meanwhile, with GPIF upping its active allocations more broadly last year, performance incentive agreements - reached with all managers selected in the fund's October 2015 foreign bond review - could also figure in its ongoing review of overseas equity managers. “We think performance-based fees are desirable for active managers,” noted Mr. Mori.

The latest fiscal year ended with 20% of the GPIF's ¥134.75 trillion in active strategies, up from 15.5% the year before.

Still, the latest fiscal year's data on long-term performance results suggest that relying on active equity managers to deliver material amounts of alpha could be a slim reed to cling to.

Over the five- and 10-year periods ended March 31, GPIF's active domestic equity managers, as a group, underperformed the TOPIX benchmark by an annualized 34 basis points and 28 basis points, respectively. Overseas equity managers added an annualized 11 basis points of alpha over five years but lagged by 34 basis points over 10 years.

Those results could leave GPIF officials more open to boosting the smart beta portion of the fund's active allocations.

If a similar 50% portion of GPIF's current ¥4.9 trillion in active international equities were slated for smart beta strategies, that would amount to just less than ¥2.5 trillion — or $24.42 billion — even without any shifts from the fund's ¥26.1 trillion in passive allocations.

Still, managers could face hard fee negotiations to win smart beta mandates. GPIF's latest data on its manager-specific remuneration, for the year ended March 31, 2015, show the fund paying Nomura 8.8 basis points and GSAM four basis points on their respective allocations.

Even so, the latest annual report showed GPIF's fee payouts hitting a record ¥38.3 billion, up from ¥29.1 billion the year before. Overseas equity managers garnered the biggest gains, up 52% to ¥17 billion.

GPIF's Mr. Mori pointed to the rise in active overseas equity assets to ¥4.9 trillion from ¥3.6 trillion the year before as the most important likely factor behind the fund's record fee total.