JP Bank CIO plots a course through 'stretched' valuations

The chief investment officer of Japan Post Bank's ¥207.1 trillion ($1.8 trillion) portfolio, who has overseen net allocations of roughly $130 billion to global credit managers over the past two years, believes valuations in key market segments such as investment-grade and high-yield bonds are now "reasonably stretched."

Still, Katsunori Sago, the former Goldman Sachs Group Inc. executive who took the helm at JP Bank in mid-2015, said in an interview it's not clear whether a correction can be expected over the coming year.

Mr. Sago conceded he is one of many investors around the globe who continue to buy those bonds even though they're not happy with current valuations. "I really don't want to buy high yield at these levels, but I have to buy it, because there's nothing else available."

As the hunt for value becomes more challenging, Mr. Sago said his team is recycling a lower proportion of the portfolio assets coming due from maturing legacy Japanese government bond positions into credit. "We invest 50% to 75% — closer to 50% — of redemption money to new investments, and the balance goes to (Bank of Japan) deposits," he said.

Mr. Sago said one-on-one meetings he had while in Washington last month at the time of the International Monetary Fund-World Bank conference showed considerable optimism among policymakers and business leaders about the state of the global economy. "Everyone is basically optimistic or at least cautiously optimistic," he said, which is "a bit scary" and points "unfortunately" to the prospect of asset prices continuing to push higher.

That cautious tone by the investment chief of a bank which, together with its affiliate Japan Post Insurance, has issued a tidal wave of credit mandates in recent years, doesn't necessarily suggest an end to those allocations.

Mr. Sago said he would look on a significant ​ correction in the market over the coming year more as an opportunity than something to be feared.

"From our point of view, if there's any large correction, mark-to-marketwise, it would be a bit painful but we have decent unrealized gains (so) losing some of that wouldn't really bother us," he said.

Meanwhile, as of Sept. 30, Japan Post Bank had ¥52.7 trillion, or roughly 25% of its portfolio, in cash, up from 20% a year or more before — an ample war chest to take advantage of any opportunities that might present themselves, he said.

Mr. Sago said he's hoping to see a correction in the coming year, but "I really don't know."

For now, Mr. Sago said his investment team is adding more passive credit exposure, awarding separate account mandates tasked with matching benchmark returns, at relatively low fees. JP Bank made its first allocations to passive credit strategies early this year after concluding that combined active allocations exceeding $250 billion were giving the portfolio more beta than alpha.

"For the last couple of months, we have been investing into passive funds more than active funds in the credit space," he said.

New active credit mandates have continued as well, although those flows have favored "a couple of managers" who've delivered attractive alpha by picking solid credits rather than relying on managing duration or other aspects of active management that JP Bank's hedge fund managers are better placed to pursue, said Mr. Sago. He declined to name the managers receiving additional mandates. Managers who have been less successful have been switched to passive strategies at lower fees, he said.

Meanwhile, in the quarter ended June 30, Mr. Sago said his team liquidated some legacy active credit investment positions that had become short-dated and were no longer offering potential for positive returns.

JP Bank's quarterly reports showed the portfolio's allocations to credit managers retreating in the June quarter for the first time since the company's listing in November 2015, dropping ¥900 billion to ¥31.6 trillion. For the quarter ended Sept. 30, those allocations rebounded ¥1.9 trillion, or $17 billion, to ¥33.5 trillion.

JP Bank's combined allocations to hedge funds of funds, private equity funds of funds (including infrastructure) and real estate funds of funds have grown to roughly ¥800 billion from ¥200 billion seven or eight months before. Those allocations will continue to grow, both in terms of assets and the range of strategies and market segments in which JP Bank invests, Mr. Sago said.

Next up, starting early in 2018, will be allocations to private debt, said Mr. Sago. Only five to 10 managers today have sufficient scale and expertise to manage the mandates JP Bank is looking to award, he said. He declined to name the managers.

In the realm of alternatives and private markets, "we will do more going forward," said Mr. Sago, noting that over the coming two or three years, his team will move beyond fund-of-funds vehicles to investments in general partner-limited partner funds, and possibly direct investments as well.

Meanwhile, progress in building JP Bank's investment team continues, with 140 investment professionals now, up from 130 in March, according to Mr. Sago.

He said he has put in place teams of more than 10 professionals apiece for private equity, real estate, hedge funds, equities, fixed income/foreign exchange and credit manager selection, with a slightly bigger lineup for JP Bank's credit investment team.

He said the bank's private equity and real estate teams could expand further "as we start doing more and more things."

Meanwhile, with affiliate Japan Post Insurance pursuing a similar buildup, Mr. Sago said there have been areas where the sister firms have cooperated, sharing information on managers, and he predicted that "cooperation will be stronger going forward."

Mr. Sago declined to rule out the possibility the two organizations could eventually "consolidate" some of their duplicated efforts.