CIO of Japan endowment faces investing headwinds

Masakazu Kita — the Norinchukin Bank veteran tapped earlier this year to helm a $90 billion endowment fund being set up to support Japan's top research universities — isn't a market timer.

If he were, he would have chosen a more auspicious moment than the current one — with the U.S. Federal Reserve preparing to pare back the extraordinary monetary policy support that levitated markets following the pandemic crash of February and March 2020 — to put tens of billions of dollars to work in global markets.

"Almost all financial products are fully or highly valued" now, which will add to the challenges of garnering strong returns and make it important to proceed in a "very deliberate manner," said Mr. Kita, vice president and chief investment officer at the Japan Science and Technology Agency, in a recent interview.

The veteran investor said in the current environment, investing in alternatives such as private equity, real estate and infrastructure will be key to meeting or topping the 4.38% annualized return target set recently by a government experts panel. While alternatives exposures will play an important role early on, he acknowledged it will take seven to 10 years to build a mature portfolio diversified by vintage year.

Formal decisions on investment policy — including asset allocation — must await the Ministry of Education's appointment in coming months of a five-member investment advisory committee under the Japan Science and Technology Agency, Mr. Kita noted.

At the same time, the Japan Science and Technology Agency, a funding unit along the lines of the U.S. National Science Foundation, is hammering out a new personnel management system and compensation structure that, by December, should allow the endowment to begin hiring needed investment staff, including alternative specialists with a "long experience investing in funds globally" and portfolio optimization/asset allocation specialists, he said.

The fund will begin investing its initial pool of ¥4.5 trillion ($41 billion) by the March 31 end of the current fiscal year. The government is asking the Ministry of Finance to approve an additional ¥5.5 trillion in equity and loans.

Takatoshi Ito, the Columbia University professor who chaired the experts panel that advised the government on the endowment's risk parameters, likewise called the prevailing backdrop a challenging one for promoting the takeup of endowment-style investing — one of the ancillary goals of the government's endowment effort in Japan.

In addition to setting the endowment's 4.38% return target, the panel established its reference portfolio as well, with allocations of 65% to global equities and 35% to global bonds.

With many now viewing equities in the U.S. and elsewhere as overpriced and quantitative easing expected to be in retreat in coming years, the timing for launching what eventually will be a ¥10 trillion endowment fund in Japan "is not ideal," Mr. Ito said in an interview.

Still, with the express goal of providing near-term support for researchers at top Japanese universities, sitting in cash for five years in hopes that the next crisis will provide a better entry point isn't an option, he said.

From a number of perspectives, getting off to a strong start could pay dividends for the government's endowment efforts, Mr. Ito said. For example, garnering healthy returns of 6% or so over the first few years — above and beyond the 4.38% needed to meet the goal of distributing inflation-adjusted investment gains of 3% per year to select universities — could allow for a reserve buffer to be set aside to cover outlays during inevitable bear markets, Mr. Ito said.

Good returns over the first two or three years, meanwhile, could help make the endowment fund a popular option for smaller universities in Japan with assets to manage, he noted. Top research universities, by contrast, will be encouraged to set up their own endowment funds, Mr. Ito said.

Mr. Kita said his more than 20 years of investment experience at Norinchukin should prove useful in his new post. Like Goldman Sachs & Co. in the U.S., the Tokyo-based bank has been a prime hunting ground for candidates to fill high-profile public positions demanding market savvy — including the last two presidents of Japan's ¥191.6 trillion Government Pension Investment Fund, Tokyo.

His career at the bank included stints overseeing "asset allocation and alternative investments" — with a record $5 billion secondaries sale of Norinchukin private equity holdings to Paris-based Ardian in 2019 — as well as fixed income, listed equity and credit investments, Mr. Kita noted.

Lessons learned over that span — such as the need to stick to a disciplined rebalancing regimen at times of extreme market stress — should prove useful, he said.

Specifically, at the March 2009 close of Norinchukin's fiscal year, which coincided with the market bottom of the global financial crisis, the bank opted to take risk off the table, losing the opportunity to fully gain from the market rebound that followed, Mr. Kita recalled.

Mr. Ito said his panel's final report to the government two months ago, which stated that "investment discipline should be maintained, including timely rebalancing," suggests a consensus on that point. "Between the lines it says, 'buy when the price goes down,'" he said.

Meanwhile, with Japan's government serving as the source of the endowment's capital, 10% in equity and 90% in super long-term loans, Mr. Kita said, "I have to consider the balance between stability or retaining … financial soundness and meeting the target return of 4.38%."

At the very beginning, the portfolio could overweight bonds and have some portion of cash while steadily making commitments to private equity, real estate and infrastructure — including secondaries in an effort to lessen the J-curve lag — leaving the portfolio ample room to rebalance during periods of market stress, Mr. Kita said.

Tail-risk strategies, whether involving derivatives or hedge funds, could be deployed as well, he said.

Mr. Kita said his experience making private equity investments at Norinchukin gives him a strong network of connections with general partners in that segment. For venture capital, by contrast, he said he will have to rely on gatekeepers early on, such as funds of funds.

While the coming investment oversight committee will make final decisions, Mr. Kita called the 5% limit the government currently imposes on public pension fund alternatives allocations too small to allow private equity, real estate and infrastructure to play a significant role in a portfolio.

Many observers see the market environment dawning now, as the Fed begins to taper its quantitative easing policies, as still largely positive for equities — even if moderately less buoyant than the past year or so.

The latest round of extraordinary policy support put in place in March 2020 came on top of an already accommodative policy mix, so beginning to pull back on those measures shouldn't be a death knell for equity markets, said Daniel Morris, London-based chief market strategist and co-head of BNP Paribas Asset Management's Investment Insights Centre.

"It's not like the Fed is shutting the party down," said Mark Anson, CEO and chief investment officer at Wilton, Conn.-based Commonfund Asset Management Co. Inc., a $26 billion outsourced CIO and private capital manager. It's more like they're setting limits on "what's going to be served at the party," he added.

Mr. Anson — who was the first of a handful of U.S. endowment veterans to appear before the experts panel advising the Japanese government on its endowment plans — said his team remains "reasonably bullish" about the outlook for equities and "slightly overweight" despite what Fed Chairman Jerome Powell said recently about moving up the timing of tapering.

Valuations are elevated now but private capital, illiquid assets and public equities remain reasonably attractive options for allocations, Mr. Anson said. "You … can't be a market timer. You still have to put that capital to work and go out and capture those long-term risk premiums," he said.