Japan's GPIF to lean on external managers in shift to riskier assets

Japan's Government Pension Investment Fund will rely on external managers of active as well as passive investment strategies as the $1.1 trillion pension fund continues its seismic shift into higher-risk assets.

Speaking June 15 at Pensions & Investments' Global Future of Retirement conference in New York, Hiromichi Mizuno, executive managing director and chief investment officer of the Tokyo-based pension fund, said it's not realistic to think GPIF can build in-house asset management teams that would be capable of competing with the world's top money management firms.

For the time being, Mr. Mizuno said, “my realistic goal is ... to build our team into a world-class manager of money managers, or in terms of alternatives, fund-of-funds manager.”

GPIF, which is legally constrained from making direct investments in equities, will continue to rely on external managers, active as well as passive, as it pushes ahead with what Mr. Mizuno said likely counts as “the most drastic rebalancing of assets in the history of pension management.”

That rebalancing, which the GPIF announced Oct. 31, 2014, boosted the fund's combined target allocation for domestic and overseas equities to 50% from 24%, while slashing Japanese government bonds to 35% from 60%.

Elsewhere, the fund's target for overseas bonds rose to 15% from 11%, while a 5% allocation to cash was eliminated. The rebalancing also set a 5% cap for allocations to alternative strategies within the fund's allocations to equities and bonds rather than as a standalone category.

As of Dec. 31, 2014, the GPIF reported allocations of 43.1% for domestic bonds; 19.8% for domestic stocks; 19.6% for overseas stocks; 13.1% for overseas bonds and 4.3% for cash. Ahead of the fund's announcement of full year results for the fiscal year ended March 31, 2015, Mr. Mizuno declined to provide an asset allocation update, beyond noting that considerable progress continues to be made.

At the fund's current size, each percentage point counts for more than $10 billion in allocations.

While GPIF's scale presents challenges in seeking alpha from active, capacity-constrained strategies, Mr. Mizuno suggested there are systemic reasons why the Japanese pension giant should continue to allocate some money to active managers.

It can be difficult to prove active managers produce enough alpha to justify their fees and the internal resources GPIF expends selecting and monitoring them, but active management is a key to ensuring the efficiency of capital markets that GPIF takes advantage of when it invests passively, he said.

If any equity market were to become dominated by passive players that could “ruin the efficiency of the market,” Mr. Mizuno said. “We'll continue to use active managers,” because at the end of the day, GPIF benefits more from “better beta than better alpha,” he said.

Asked about alternative investments, Mr. Mizuno said GPIF is in no rush to throw money at private market investments, even as it continues to lay the groundwork to pursue such investments. The 5% figure for alternatives cited in the asset allocation the GPIF adopted in October 2014, is an “opportunity for us, not an obligation,” he said.

Even so, the GPIF is hiring private markets experts for its internal staff, and will pursue compelling opportunities as they present themselves, Mr. Mizuno said. With room to invest up to $70 billion to $80 billion in alternatives, “as soon as we build a team, and as soon as we see compelling opportunities, we hope we'll be a significant player” in private markets, he said.

Mr. Mizuno also suggested that GPIF is poised to pay more attention to environmental, social and governance factors as it invests — incorporating “the philosophy of ESG into our thinking,” even if that doesn't mean extending mandates to ESG-focused funds.

Without outlining any potential implications for GPIF's operations, Mr. Mizuno said he feels “socially responsible” to keep such considerations in mind while investing. Noting the fund's mandate to fill the gap between pension contributions and benefit payouts guaranteed by Japan's government over the next 100 years, the CIO said he “sees no point” in his great, great grandchildren receiving a “pension benefit in full when the temperature is 110 degrees Fahrenheit.”

In that context, it's obvious that a company could make more money by ignoring carbon emissions, “but are you happy as a shareholder? I am not,” he said.

Finally, Mr. Mizuno rejected criticism that GPIF's shift to higher-risk assets has effectively made the fund a tool of Prime Minister Shinzo Abe's administration, in its efforts to spur Japan's economy by lifting stock prices. Instead, against the backdrop of the Abe administration's efforts to lift the economy out of a prolonged deflationary spiral, the shift out of bonds is a sensible move to derisk, he said.

Meanwhile, Mr. Mizuno cited reasons for optimism about the pace of structural reforms in Japan's economy, the third pillar of Prime Minister Abe's economic program — following fiscal stimulus and monetary easing. Two and a half years into the program, that third policy “arrow” has been widely derided for lack of significant progress.

Mr. Mizuno said he felt Japan's efforts at structural reforms, which by their nature “can't possibly change overnight,” were being underappreciated. He cited two recent changes as evidence: a concession earlier this year by Japan's Central Union of Agricultural Cooperatives — “the strongest lobby for the ruling party” — that weakened its influence, and a reform to Japan's national health-care system, long opposed by the country's doctors' association, allowing patients to seek treatment from private as well as public health-care facilities.

While such changes are “very difficult to see from a distance,” there's growing reason to believe “we are moving in the right direction,” he said.