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GPIF currency hedging could help in downturn

Norihiro Takahashi sees the pension fund’s fixed-income holdings as a cushion to equity market declines.

Expansion of program would be good news for return profile

Currency hedging could help make Japan's Government Pension Investment Fund more resilient if a global slowdown threatens to claw back some of the heady equity-fueled gains the Tokyo-based plan racked up in recent years.

Norihiro Takahashi, president of the 165.6 trillion ($1.45 trillion) pension fund, said in an interview that the GPIF has begun hedging a portion of its 15% foreign bond allocation and is open to doing more "if we predict the value of the yen will go up."

That, in turn, could leave the fund's 25 trillion foreign bond allocation better positioned to cushion any downside for the GPIF's portfolio if and when the past decade's global bull run for equities draws to a close.

Since October 2014, when the GPIF doubled its target for equity to 50% and slashed its target for Japanese government bonds to 35% from 60%, the fund's fortunes have waxed and waned — but mostly waxed — in tandem with global equity markets.

For the quarter ended Sept. 30, GPIF reported combined investment gains of 5.3 trillion on its holdings of domestic and overseas equities — 98% of its overall 5.4 trillion for the period. For the prior quarter, equity-related gains accounted for 93% of the total.

But in recent months, the bull market has shown growing signs of fatigue, with the S&P 500 benchmark index off 9.7% since the start of October — just short of a 10% correction.

Mr. Takahashi said the GPIF, as a long-term investor, is more focused on the positive backdrop from the growing ranks of people — especially in emerging markets — participating in and benefiting from the global economy than on signs of short-term weakness.

However, in the event economic headwinds emerge and push equity valuations lower, Mr. Takahashi predicted the fund's allocations to overseas bonds and, to a lesser extent, its 25% holdings of Japanese government bonds sporting negligible yields, will provide some cushion for the portfolio.

But in recent years, the yen's status as a safe-haven currency for investors when market volatility spikes has made the GPIF's foreign bond allocations — which were entirely benchmarked to non-hedged indexes as of March 2018 — a less than reliable cushion.

For example, over the past 10 quarters, only two quarters — the ones ended June 30, 2016, and March 31, 2018 — ended with sharp declines for global equities. In both instances the yen appreciated against the dollar, by 8% and 6%, respectively. Instead of offsetting the fund's equity-related losses, the GPIF's foreign bond allocations piled on trillion-yen losses of their own.

Regulatory change

Earlier this year, GPIF won greater latitude to hedge its overseas currency exposures, on the back of a regulatory change permitting the fund's internal investment team to use exchange traded derivatives for risk-mitigation purposes.

Mr. Takahashi declined to provide details on the fund's currency hedges but noted the huge scale of the GPIF's portfolio makes it impossible to hedge all of its almost 70 trillion in foreign exposure.

In other areas where allocations could be tweaked to lower volatility, Mr. Takahashi insisted that moving gradually and steadily remains the best means of achieving the GPIF's long-term goals. For example, while he had previously pointed to investing in infrastructure, real estate and private equity as a means of tempering portfolio volatility, Mr. Takahashi said it's a process that can't be rushed. Over the past 12 months, the GPIF hired three infrastructure fund-of-funds managers and two real estate fund of funds, with allocations as of Sept. 30 coming to 300 billion, an 18-basis-point share of the portfolio. Mr. Takahashi said that by the end of March, he hopes to hire the fund's first private equity fund-of-funds manager.

Just more than 10 of GPIF's 120 employees are alternatives investment professionals. Finding those rare individuals who can not only source deals but put together a portfolio of alternative investments could set the stage for a pickup in the pace of allocations, he said.

Likewise, Mr. Takahashi said he isn't looking to take advantage of a September tweak to the GPIF's policy guidelines — allowing the fund's allocation to Japanese government bonds to fall below a 25% rebalancing tripwire — to make major changes. The policy change applied that 25% JGB allocation floor to the fund's combined holdings of JGBs and short-term cash instruments — currently about 34% of the portfolio. Technically, those rules would allow the GPIF to move 10 or 20 percentage points of allocations from JGBs to cash. But Mr. Takahashi said with the rule change only in effect through the March end of the current fiscal year, making sizable shifts out of JGBs with no guarantee the policy will remain in effect next year would be unwise.

Instead, Mr. Takahashi said any asset allocation changes beyond the five-year policy targets announced in October 2014 will have to await the fiscal year that starts in April 2020, when the government will announce the fund's new benchmark portfolio for the following five years.

For now, Mr. Takahashi said the fund remains focused on promoting environmental, social and governance-related standards as a means of boosting the efficiency of the market and sustainable investment returns. He said the GPIF's latest move in that regard was to award a research mandate to Tokyo-based Nissay Asset Management to study the way companies and asset managers around the world are disclosing ESG-related information. A news release by the Japanese money manager said the study, in part, will involve a comparative analysis of ESG information disclosure standards and frameworks around the globe.