The adoption, or not, of the recommendations made last week by a panel reviewing management of the 120 trillion yen Government Pension Investment Fund, the world’s largest institutional investor, will depend on three factors:
* The constant competition for status that characterizes the Japanese public service and whether the Ministry of Health, Labour & Welfare (MoHLW), of which GPIF is part, sees implementation as advantageous to its standing within that system — especially vis à vis the Ministry of Finance.
* Who government decides will hold the bulk of its enormous debt if the inflation target of 2% is met by the end of 2015 and the Bank of Japan ends the massive purchases of Japan Government Bonds (JGBs) which are at the heart of its quantitative easing programme.
* The value of the yen, since without a level perceived as durably weaker than 100 = US$ the much needed increase in allocations to foreign securities will be impossible and that will, in turn, impact the disposition of domestic investments.
More modest than the wishful thinking of the pre-publication media coverage, which foresaw the Fund moving into every market on earth, the proposals should still change the landscape for fund managers and other intermediaries – though not in the short run.
Looming over every aspect of GPIF’s investment choices are the demographics that have already pushed it past the tipping point to where it will forever have more going out in annual benefits than coming in via contributions.
The MoHLW accrets power
Since it acquired oversight of the formal pensions system in the mid-1960s, the MoHLW has had a long history of successfully expanding, but never contracting, its remit.
In 2001 it absorbed the Ministry of Labour and its oversight of an estimated 505bn yen in zaikei accounts – savings plans set up by employers via contracts with financial institutions.
The same year the 70,000+ so-called Tax-Qualified Plans overseen by the Ministry of Finance, and worth over 22.7tr yen, were obliged either to close (which about two-thirds did) or convert to a new scheme structure regulated by MoHLW where responsibility for the type known as Employee Pension
Simultaneously, the name of Nenpuku, the MoHLW arm managing that part of Employee Pensions Insurance (EPI) not invested by EPFs on government’s behalf plus that part of basic pensions contributions not paid out immediately in benefits, was changed to GPIF. (Nenpuku is the Japanese acronym of Pension & Welfare Public Service Corporation).
This re-organisation included provision for those EPFs which wished to do so to start handing over responsibility for managing their EPI accounts to GPIF.
Better still, it brought to an end the humiliation suffered by the MoHLW from having to turn over a very large part of its hoard to the Ministry Finance’s Trust Fund Bureau. Further, it was agreed the Fiscal Investment & Loan Program, into whose paper the money had been sunk, would pay back on maturity and the debt would rolled over no more.
As a result of these moves the GPIF’s assets under management zoomed by over 300% in the next eight years, with extent of the shift in EPI management probably proving greater than anyone had expected. Today FILP holdings are down 8.86% of the portfolio compared with over 30% in 2002.
More striking still is the recent growth in the passively managed bonds, overwhelmingly JGBs, under inhouse management. This has shot from 10.9tr yen at the 31 March 2010 year-end to 29.37tr yen three years later.
When the amount in short-term funds and FILP debt is included, the Fund’s own team has stewardship of over 40bn yen, or 33% of the portfolio. About half, sometimes dubbed the ‘cashout’ portion, is kept in this way because with the fund in decumulation mode it will be needed to pay benefits over the next 4-5 years.
The review panel’s ponderings also came to cover the 15.8tr yen portfolio of the Pension Fund for Local Government Officials (‘Chikyoren’, see archived profile 8 November and ‘The Giants’ tab at top), the 7.3tr yen holdings of the Federation of National Public Service Personnel Mutual Aid Association and the 3.4tr yen of the Promotion & Mutual Aid Corporation for Private Schools.
Why it did so is not clear. While all of these funds can be described as ‘public’ it is in a quite different sense from the Fund.
Supervised by the Ministry of Finance, MAAs are mostly civil service retirement schemes and the only job-based collective pension arrangements not to be overseen by the MoHLW. As it has been trying to bring them within its ambit for years, perhaps it could not resist the temptation to ask that they be counselled too.
Who will hold huge debt?
The report talks of cutting back GPIF’s allocation to domestic government bonds to less than today’s 53% level. However, this proportion sinks to only around 31% when amounts set aside for benefit payments due in the next 4-5 years are excluded.
Moreover, such a cut is a purely political decision – as was putting so much of the Fund into roads that go nowhere via the ‘pump priming’ activities of the MoF’s FILP.
Dressing up the idea as the proposal of an advisory panel suggests that a decision will be made within the 12-18 months on who the next generation of JGB holders is to be.
This will be necessary for several reasons.
* At the end of June the Bank of Japan held 15.4% of JGBs in issue compared with 9% in December 2011. The proportion is likely to increase before the end of the 2015 financial year which is the government’s target for reaching a 2% annual inflation rate. At that point the monetary easing which necessitated the purchases can be wound down. How this will be done has yet to be decided.
* The commercial banks which have passed part of their huge their holdings to the central bank have done so to give themselves more room for lending and to avoid the impact on their balance sheets should the value of the bonds sink
* Japan Post Group (see tab at top) which in both its Post Bank and Post Insurance incarnations has massive but recently diminishing holding of JGBs and is planning to float on the stock exchange in the 2015 financial year. The Group is to publish its business plan in February next year.
* Many civil service mutual aid associations are underwater and can no longer afford their ‘duty investments’ in JGBs.
The nature of the life companies’ obligations means that they are more reliable holders but even they will be looking abroad in the right circumstances. They have also been actively buying stakes in foreign firms and thus acquiring greater understanding of securities markets beyond their borders.
Demographics drive allocations
The shrinkage in Japan’s workforce now swelling the ranks of its retirees (see tab at top ‘Story in graphs’) will also limit the country’s economic growth and thus its domestic investment opportunities, pushing the Fund to seek rewards from growth abroad.
Even where there is potential growth at home it is in markets such as private equity which are so small they would burn up if GPIF were to make commitments of sufficient size to improve the Fund’s returns.
Such investments are also illiquid and while the panel’s report draws attention to the performance of private equity investors such as the Canadian Pension Plan, the USA’s Calpers, the AP1-4 component of Sweden’s national pension fund and Holland’s ABP these funds are in a different demographic place.
It’s the yen, stupid
The barrier to investing abroad has long been the inexorable 40-year rise in the yen which has wiped out most gains on translation to the home currency. GPIF is one of very few investors prepared wait out a trend of such persistence and its 26% allocation to foreign securities looks courageous in this context.
Earlier this year, when confidence that Abenomics would set the economy on a new road was higher than today, there were forecasts that the yen: dollar rate would reach 120 in 2014. It last saw this level, briefly, in mid-2007 and before that in December 2002.
Yet BNP Paribas global FX strategist Steven Saywell was telling the Financial Times at the end of last week that his firm was again forecasting 118-120 for next year, though not in the ‘near-term’ and for reasons associated with the US – not the Japanese – economy.
When GPIF, the MAAs and Japan’s thousands of corporate retirement schemes sit down in January to finish setting their asset allocations for the financial year starting on 1 April, their near term will be only a few weeks away.
If the yen can stay above the psychologically important US$1=100 yen until that time, corporate pension funds will provide the first wave in a tide of pensions money going abroad.
Once the money starts to flow it will reinforce the downward trend in the yen as will any continuous improvement in the US economy. That, in turn, will make Japanese exports cheaper and so boost domestic manufacturing, companies’ investments and wages.
Inflation goal in doubt
It is still doubtful that this will raise the country’s inflation rate to 2% by the end of the 2015 financial year on 31 March 2016, but it will change the context in which the Ministry of Finance and Bank of Japan decide who will hold government’s debt in future.
For GPIF this relates not so much to the 22% of its assets kept in JGBs in order meet the benefit obligations coming due in the 4-5 years but to that which forms a further 31% of its portfolio. If that could be halved 17-18tr yen would be freed up for other investments.
Such a decision could be made after the results of the MoHLW’s latest 5-year actuarial review are delivered in March next year. The Fund will then take several months to decide its medium-to-long term asset allocation.
Restructuring its governance and policy-setting procedures will also be time-consuming.
The MoHLW can change but it needs to be lured by the prospect of gaining prestige. In the late 1990s it appeared to drag its feet on implementing the 1995 deregulation that allowed fund managers into the pensions business for the first time until the bright star of the 2001 reforms glimmered into view.
Brought into process early on this time, the Ministry seems to have flexed its muscles to biff away the idea of splitting GPIF into smaller competing funds and have it replaced by a proposal to establish ‘baby’ pools within it.
Pay + prestige = transparency?
The review panel’s report notes that if the Fund is to invest in a wider range of markets, the personnel and expense restrictions imposed by past cabinet decisions will need relaxing. This is something the Ministry can get behind.
So too is a proposal that GPIF be re-organised under a new law catering to its unique position and bestowing more authority and independence.
The high degree of transparency and accountability it is supposed to offer in return for this would be anathema to the Ministry but ways could no doubt be found to weaken such a commitment in practice.
Over the next 18 months asset managers worldwide will be seeking to put before GPIF the specialist products they believe could put it on the path to better returns.
Those with offices in Tokyo will try to do that directly but those without such a presence would be better off leaving the presentations to one of the Big Three trust banks and taking up sub-advisory roles.
© 2013 Japan Pensions Industry Database/Jo McBride. Reporting on, and analysis of, the secretive business of Japanese institutional investment takes commitment, money and time. This blog is one of the products of such commitment. It may nonetheless be reproduced or used as a source without charge so long as (but only so long as) the use is credited to www.ijapicap.com.
This blog would not exist without the help and humour of Diane Stormont, 1959-2012