Japan Pensions Bet on Hedge Funds
Japan's corporate pension funds, hobbled by a sluggish domestic stock market, are raising their allocations to hedge funds as they scramble to boost returns for the country's ageing population.
The move is part of a broader trend in Asia where institutions are looking to raise exposure to hedge funds in search for absolute positive returns and as confidence in the asset class improves, lifting prospects for the $2 trillion (1.2 trillion pound) global hedge fund industry.
Nearly all of Japan's corporate pension funds, which collectively manage more than $900 billion, have lowered their guaranteed yield in the last decade from about 5.5 percent to below 3.5 percent on average, industry observers said.
"Considering that they have had a very hard time raising decent returns by directly investing in equities over the past years, pension funds are now very seriously considering taking more exposure in alternatives," Tamotsu Adachi, the co-head of private equity firm Carlyle's Japan unit, told the Reuters Rebuilding Japan Summit in Tokyo this week.
A survey of 31 Japanese corporate pension funds by U.S. fund manager Russell Investments showed pensions slashing investment in domestic equities to 14.6 percent of their assets on average as of end-March from 18.7 percent a year earlier.
By contrast, the 31 pension funds, which manage 7.54 trillion yen, said they had increased allocations to hedge funds and other alternative assets to 13.1 percent of their assets from 11.6 percent a year ago.
"In these conditions where Japanese pension funds are having trouble finding a return driver, they have to rely more on alternative assets, mainly hedge funds," said Mitsuhiro Arakawa, executive consultant at Russell Investments.
"They don't want to be in stocks after seeing them slump over the last 10 to 20 years. In fact, they may want to cut them at a quicker pace after the disaster in Japan," Arakawa said.
The blow of the March 11 earthquake and tsunami and ensuing nuclear crisis knocked the Japanese economy into recession and battered stocks. Japan's benchmark Nikkei average is still down about 7 percent since the earthquake.
Some corporate pensions are aiming to park as much as 40 percent of their assets in hedge funds, said Futoshi Ago, director at the prime brokerage arm of Bank of America Merrill Lynch in Tokyo.
Takahiro Mitani, president of the Government Pension Investment Fund, told the summit that while he had no plans to start investing in hedge funds immediately, the fund was evaluating the option. The GPIF, which holds about $1.4 trillion in assets, is known as a conservative fund that parks about two-thirds of its assets in Japanese government bonds.
The Nikkei stock average has lost about a third of its value in the last 10 years. By comparison, the Eurekahedge Hedge Fund Index has surged 160 percent, forcing institutions to rejig their asset allocations.
While Japanese corporate pension funds have kept their allocations to foreign stocks at around 20 percent of their assets in the past decade, they have cut their exposure to domestic shares by half. Investments in alternatives have risen to 13 percent from less than 3 percent.
Across Asia, institutions are preparing to invest more or are looking to start investing in hedge funds, after shying away from the asset class, as an uncertain economic outlook forces them to look at instruments that could benefit from falling markets.
South Korea's National Pension Service, the world's No. 4 pension fund with about $300 billion of assets, said earlier this month that it plans to raise its investment in alternatives to above 10 percent by 2016 from 5.8 percent in 2010 as a part of its move to diversify.
The industry has also received allocations from Chinese, Taiwanese and Malaysian institutions among others in Asia with more likely to join the fray.
"The market is far more ready now to make allocations to hedge funds. Clearly I think that the large institutions are setting the path for others to follow," said Max Gottschalk, co-founder of Gottex Fund Management, one of the world's biggest fund of hedge funds.
Only about 18 percent of global hedge fund assets are sourced from Asia, according to a Credit Suisse survey of 600 institutional investors representing $1.2 trillion of allocations to single-manager hedge funds.
"I think we are still in the early phase of adoption to alternatives in Asia and I think over the next 5-10 years Asia will become a far more prominent investor in this asset class," said Gottschalk who moved to Hong Kong earlier this year.
Several thoughts came to me as I read this article. First, global assets into hedge funds are growing ever larger, meaning their influence in financial markets will become even more important. This is another source of liquidity and leverage, and keep in mind most hedge fund assets are in directional strategies: Long/Short Equity, global macro and commodity trading advisors (CTAs). This means you will see ever larger swings in risk assets on the way up and on the way down.
Second, with an aging population, Japan's corporate plans need to manage liquidity risk very carefully. This too means they will be biased towards directional absolute return strategies where liquidity and scalability are not as much of an issue as market neutral strategies. The problem is that there a lot of beta in these directional strategies and these corporate plans don't want to end up paying 2 & 20 in fees for beta.
Third, Asian institutions have an advantage of knowing who the good managers are in their own backyard but I would recommend they diversify into North American and European funds. They can go the fund of funds route, but they will end up paying an extra layer of fees, which might work fine until the next global crisis hits. These corporate plans need a strategy, and I would recommend managed account platforms (not just brand names) and direct investment into hedge funds. This is where funds like Ontario Teachers' are moving and for good reason, they and others got hammered with illiquid hedge funds putting up gates (and side pocket letters) during the 2008 crisis and are now managing liquidity risk much tighter.
Fourth, I worry that all these assets flowing into global hedge funds will dilute returns going forward and sow the seeds of the next crisis. It's not guaranteed but you have to pay attention to global trends in hedge funds because they're increasingly becoming the alternative investments of choice for global pension funds looking to juice their returns while they manage liquidity risk very closely.
Finally, there is an intelligent way and a dumb way to invest in hedge funds. I'd be glad to discuss some more ideas with these Japanese corporate pension plans and introduce them to some of Quebec's absolute return managers. In particular, one experienced manager who is setting up his relative value commodities trading fund with his partners, is a perfect fit for these plans. If you're interested in knowing more, please contact me at LKolivakis@gmail.com.