Defined benefit corporate pension funds in Japan are increasing their allocation to domestic bonds, and will likely continue to do so as Japanese interest rates rise, said Kaguya Komatsu, head of Japan funds business and institutional business at J.P. Morgan Asset Management.
The fund manager released a report August 8 that found that Japanese DB corporate funds have started increasing allocations to domestic bonds in their policy asset mix for the first time since 2009.
Although the allocation increase was only by 10 basis points to 15.1%, Komatsu said the change is symbolic of a longer-term trend.
“The domestic bond ratio has consistently decreased since the survey began at the end of March 2009 and this is the first year DB pensions are considering increasing domestic bonds in the future. We believe the latest figures show signs of bottoming out and indicate a direction of increase in the future. It may suggest that DB pensions are at a turning point,” she said.
“If Japan's 10-year interest rate reaches 1.5% or 1.25%, it is believed that investment in domestic bonds will progress,” she added.
The JPMAM Japan Corporate Pension Funds Survey Report 2024 was the result of interviews with 80 pension and mutual aid funds and found that 10.1% of funds planned to increase allocation to domestic bonds.
Allocations to domestic bonds have begun increasing rapidly, the report said.
“Since the improvement in the yen’s interest rate environment has allowed them to make new investments at higher yields, more assets are likely to be allocated to domestic bonds and general accounts in their portfolio,” it said.
The survey referred to the Nomura BPI Total Index as a measure for domestic bonds, which primarily comprises Japanese Government Bonds and a small portion of corporate bonds, Komatsu said.
The Bank of Japan in early August hiked its key interest rate to 0.25% from a range of zero to 0.1% and had earlier offered to buy 10-year JGBs at 1%, effectively raising the yield cap.
Japan's corporate pension funds have also started reducing foreign exposures due to high hedging costs. Around 12.6% of respondents planned to reduce allocations to foreign bonds compared with 7.6% that planned to increase allocations and 7.5% planned to decrease allocation to foreign equities compared to 6.3% that planned to increase allocation.
“With the guaranteed interest rate (DB’s target return) as low as 2.3%, DB pensions are looking for assets that can provide stable returns. Assets with high expected returns but high volatility, like equities, are not preferred, and investments are expected to continue within the scope of diversified investments. Given the high hedging costs, interest in domestic bonds is expected to increase,” she said
“Due to the high hedging costs of USD/JPY, even if the interest rate in USD is high, the yield after yen hedging is almost zero,” she added. “This affects overall returns, so some DB pensions have reduced their currency hedging ratios.”
The move towards domestic assets is likely to extend to alternatives as well, she said.
“DB pensions have historically invested in alternative assets with high returns after yen hedging, but it is expected that they will also consider domestic assets without hedging costs in the future,” she said.
JPMAM managed $3.3 trillion in assets as of June 30.
