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  2. PENSION FUNDS
July 22, 2019 12:00 AM

GPIF's alignment push sparks sharp fee drop

Payments to managers plunge 40%, lowest level since 2015

Douglas Appell
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    Norihiro Takahashi
    Kiyoshi Ota/Bloomberg
    CEO Norihiro Takahashi said it’s too soon to fully evaluate the outcome of the new fee plan.

    Updated with correction

    A year after Japan's ¥159.2 trillion ($1.48 trillion) Government Pension Investment Fund introduced performance-based fees to foster "win-win" relationships with its external managers, the first official results released by the Tokyo-based giant this month suggest many aren't feeling like winners.

    The annual report for the institutional heavyweight overseeing more than half of Japan's pension assets released July 5 showed GPIF's payments to managers for the fiscal year ended March 31 plunging 40% to ¥29.5 billion, or $273 million, from a record ¥48.7 billion yen the year before.

    Those payments came to just 2 basis points of GPIF's world-topping pension portfolio, a drop from 3 basis points the year before. It was the lowest level since the fiscal year ended March 31, 2015, when the fund — with ¥127.3 trillion in assets at the time — announced plans to more than double its portfolio's equity allocation target to 50% and slash its Japanese government bond target to 35% from 60%.

    The reductions over the past year have effectively made GPIF a poster child for efforts by asset owners around the world to reduce the fees they pay external managers — even as the fund's executives insist they're targeting better alignment of interests with managers, not lower fees.

    Fee revenues for money managers have been falling globally by 5% a year but the "highly concentrated" nature of Japan's institutional market makes the trade-offs facing managers there especially stark, said Amanda Walters, a senior manager with money manager consultant Casey Quirk, a business of Deloitte Consulting.

     

    Passive strategy fee

    Under the performance-based fee framework GPIF introduced for all external managers in April 2018, active managers who fail to beat their benchmarks only receive fees equivalent to what a passive strategy for their asset class would get.

    For managers beating their benchmarks, fees increase in relation to the alpha they deliver, reaching the level GPIF paid under the prior fixed-fee system only if a manager achieves the target return agreed upon in discussions with GPIF, said Naori Honda, a GPIF spokeswoman.

    If managers exceed their alpha targets, GPIF will pay more than what it paid under the prior system — a situation beneficial to both sides, Ms. Honda said.

    Under the new system, then, GPIF's target return negotiations with managers are the main arena for both side's efforts to tilt the system in their favor. Managers have incentive to set targets as low as they can without hurting their ability to win mandates. By contrast, GPIF's interests are better served by setting targets as high as possible without scaring off managers.

    Market veterans speculate that the absence of Boston-based money management giant Wellington Management Co. from GPIF's latest list of foreign equity managers — for the first time in five years — is a case of a manager walking away from the new system. GPIF's Ms. Honda and Sara Lou Sherman, a Wellington spokeswoman, both declined comment.

    All other things equal, last year's 40% plunge in fee payouts suggests GPIF dominated those target-return negotiations.

    The annual report — the one time each year GPIF provides information about the performance of specific managers and the fees it pays them — showed managers of 25 of the fund's 49 active bond and equity mandates failing to beat their benchmarks for the 12 months through March 31.

    The hit to those managers' fees has been dramatic.

    For example, according to Pensions & Investments' calculations, Pacific Investment Management Co. — the only manager among nine overseeing active domestic bond mandates to trail its benchmark last year — saw its fees for managing ¥551.2 billion in Japanese government bonds plunge 89%. The Newport Beach, Calif.-based bond giant's fees dropped to ¥58.6 million, or a little over one basis point of its portfolio, from ¥522.4 million for the year ended March 31, 2018.

    A PIMCO spokeswoman declined comment.

    (From the fiscal year ended March 2016, GPIF switched to providing manager-specific fee figures for three-year periods, ending its practice of releasing single-year fee data. Single-year fee data for managers with mandates dating back to the fiscal year ended March 2014 can still be calculated; fees for managers with more recent mandates can only be judged on the basis of rolling three-year averages.)

    Even Manulife Asset Management (Japan) Ltd., which topped that group of nine active domestic bond managers for the past year with 78 basis points of alpha, apparently still fell short of its target. According to P&I's calculations, the fees Manulife garnered dropped 21% to ¥189.2 million, or roughly 4.4 basis points on a ¥427.5 billion mandate. A Manulife spokesman declined comment.

    Of GPIF's four principal asset segments — domestic and overseas stocks and bonds — domestic and overseas bonds, with ¥42.3 trillion and ¥27.8 trillion, respectively, of the fund's portfolio saw the sharpest drops in manager fees. Fees for domestic bond managers plunged 60% from the year before to ¥1.6 billion, while overseas bond managers saw fees drop by 47% to ¥7.5 billion.

    Only six of the managers overseeing GPIF's 18 active foreign bond mandates managed to beat their benchmarks for the past year.

    BlackRock Inc., toward the middle of the pack last year among GPIF's active overseas bond managers, trailing its benchmark by 67 basis points, saw its fees — again according to P&I's calculations — tumble 74% from the year before to ¥109.1 million, roughly equal to 2.4 basis points on its ¥447.6 billion portfolio. A BlackRock spokeswoman in Tokyo declined comment.

    But the year wasn't without success stories. Among GPIF's 14 active domestic equity managers, Atlanta-based Invesco Ltd. and Austin, Texas-based Dimensional Fund Advisors LP beat their one-year benchmarks by 7.1 and 7 percentage points respectively, more than 4.5 percentage points better than the next-best performer.

    Invesco saw its three-year average fee improve to ¥570 million from ¥423 million the year before, while DFA — subadvising a GPIF strategy for Tokyo-based Nomura Asset Management — boosted the three-year average for fees being split by Nomura and DFA to ¥460.9 million from ¥328.8 million.

    Similarly, UBS Asset Management, Zurich — top performer among GPIF's eight active overseas equity managers last year with alpha of 5.51 percentage points — saw its three-year average fee jump to ¥2 billion from ¥1.45 billion.

    Even so, on the whole, the fees GPIF shelled out last year declined for every asset class. Managers of overseas equities took in ¥10.7 billion in fees, down 37% from the year before, while domestic equity managers saw a 29% drop to ¥7.5 trillion.

    Tokyo-based money management executives — firms currently managing money for GPIF and potential managers alike — called the new system a considerably tougher environment for them.

    Business could prove especially challenging for firms that start off with a bad year. GPIF will carry forward any losses, leaving them underwater and potentially earning passive fees for a number of years, noted an executive with one of GPIF's current external managers, who declined to be named.

    The head of Japanese institutional sales for another foreign manager in Tokyo not managing money currently for GPIF, who likewise declined to be named, said in this new environment, bulge-bracket managers with scale will be much better placed to respond to GPIF's extensive client service demands — leveraging revenues earned from other clients to tide them over should they face years of passive fees with GPIF.

    For smaller firms, which might have to hire another client service professional or two to handle a GPIF mandate, the calculus for considering whether to bid for GPIF's business has become a lot tougher, said the institutional salesman.

    Even so, GPIF controls such a large part of the market that most firms will probably pursue the business and "see how it goes," he said. At current fee levels, however, it's hard to anticipate a "win-win" situation, he added.

     

    Work in progress

    GPIF officials concede the new system is a work in progress, with better alignment of interests between the fund and its managers the long-term goal.

    The new system "has just been introduced, so it's too soon to evaluate the outcome," said Norihiro Takahashi, GPIF's president, speaking to reporters following the release of the annual report.

    Long-term "win-win" relationships with managers are the goal, he said. Through ongoing dialogue with those managers, "we want to improve the system" going forward, he added.

    Mr. Takahashi cited the five-year contracts GPIF awarded all of its managers last year as another element of that long-term plan.

    Achieving alignment is "a long-term journey," said GPIF spokeswoman Ms. Honda.

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