Thursday, March 15, 2012

Tale of Trouble at Japan Pension Funds?

Atsuko Fukase of the WSJ reports, Tale of Trouble at Japan Pension Funds:
A scandal involving the alleged disappearance of billions of dollars in pension-fund money is highlighting an uncomfortable truth here. Most of the pension plans set up by groups of small businesses in Japan are under water, the latest data from the health ministry shows, even as the burden of future payouts grows in step with the aging of the country's population.

Last month, Japanese financial regulators alleged that most of the roughly ¥200 billion ($2.4 billion) in funds overseen by AIJ Investment Advisors Co.—an asset manager that specialized in handling such small-business pensions—was missing. Regulators are still investigating.

As regulators step up their probe into what happened to that money, pension-industry experts say that the desperate straits of many of small-business funds, which were pinched between poor returns on investments and the need to pay steep pension benefits to growing numbers of retired employees, appear to have pushed them into higher-yielding investments, such as those offered by AIJ.

"They had no choice but to shift into high-return products to offset losses from the market turmoil," said Hideomi Miyahara, president of Risk Management Services Inc., a Tokyo pension-consulting firm.

About 75% of the nearly 600 pension funds in Japan set up by small businesses in sectors like transportation, construction and textiles didn't have enough assets to cover expected payouts in 2010, according to Japan's Ministry of Health, Labor and Welfare. That percentage shot up from just 7% in 2006, as markets reeled from the global financial crisis of 2008 and subsequent years of downturns.

More recent figures aren't available, but analysts tracking the industry say underfunding remains a problem. Markets haven't performed well enough to allow funds to make up their shortfalls.

The problem, pension-industry trackers say, is that many of these funds are managing money their employees have paid into government pension plans that guarantee returns of 5.5%. Management of the money was transferred to the funds in the 1990s, when markets were booming, but the 5.5% guarantees remain in place.

Yet traditional investments like stocks and bonds now return much less than that. Between 2006 and 2010, the Nikkei 225 Stock Average fell 37%, and the yield on 10-year Japanese government bonds slid to 0.8% from more than 2%. The yield on 10-year government debt is now around 1.01%, and although the Nikkei has risen almost 19% so far this year, it declined 17% in 2011.

To fill the growing gap between assets and liabilities, managers of some of the worst-off pension funds turned to more speculative investments that seemed to offer better returns, pension-industry trackers say. Daiwa Research Institute, which conducts surveys of funds set up by small businesses, says that they are increasingly investing in hedge funds, commodity futures and stocks in emerging markets. About 95% of 161 such funds surveyed put money in hedge funds in 2011, up from 89% of 206 funds surveyed in 2006, according to Daiwa.

Despite the increasing riskiness of their investments, many funds have little expertise in asset management—particularly those set up by groups of small businesses, which typically rely on investment advisers to decide where to put the money they collect from their members.

Nearly 80% of corporate pension funds in a health ministry poll released this month said their staff had no experience in managing assets before they were hired. Some 60% had no outside investment specialists in their asset-management committees.

The rapid aging of Japan's population, more than 25% of which is expected to be above retirement age by 2015, is compounding difficulties. In many Japanese funds, the number of people receiving pensions already exceeds those paying into funds, analysts say.

All those challenges were on view among AIJ's clients. At one pension fund set up for small taxi companies in the Chubu area of central Japan, most employees are over 60, according to the fund's director, who is concerned the pension plan's member companies would be upset if details about their fund were released. Already, the number of pension recipients exceeds the number of employees paying into the plan by 41%, he said.

The funds' returns to beneficiaries are set at 5.5%, so the 7% to 10% yields AIJ was promising looked attractive, the director said. The pension fund entrusted ¥1 billion, about 10% of its total assets, to AIJ, and placed the rest with several other advisors who put the money in investments like hedge funds and emerging markets, the director said.

"We've already increased pension contributions and can't lower payouts, so we hired several investment advisors including AIJ to put money in alternative investments," said the director, who added that he isn't a financial specialist.

Officials with Japan's Financial Services Agency probing the company can't locate about 90% of the roughly ¥200 billion in funds it had under management, according to people familiar with the situation.

Inspectors are still looking at whether AIJ placed pension money it managed into private investment trusts in the Cayman Islands, according to a person familiar with the matter. Accounts also may have been set up with financial institutions in Bermuda and Hong Kong, according to the person.

While such moves wouldn't violate Japanese law, regulators are checking on overseas accounts to pin down the status of the funds, according to this person.

Regulators have halted operations at AIJ until March 23.

Calls to AIJ were routed to a voicemail message requesting callers to try again later. The company's lawyer has said AIJ executives are cooperating with regulators.

The Financial Services Agency is now undertaking a review of all Japan's investment-advisory firms in the wake of the AIJ allegations. The director of the Chubu taxi-company fund said he will cancel all the fund's investment-advisory contracts while that is going on. "We will see how the FSA inspection goes,'' he said. "Until then we'll leave our money in trust-bank accounts.''

I read this article and winced. If these allegations are true, it's truly tragic that such a pension scandal is happening in Japan. They should set up a well-governed defined-benefit plan for these small businesses. I recommend we do the same thing in Canada and the United States.

Just as Japan's quake and tsunami disaster took an especially harsh toll on the elderly (watch below), the same group will feel the harsh effects of Japan's pension tsunami. They need to do a lot more, including following Malaysia's pension fund, the second-largest state-run pension system in the Asia-Pacific region, which plans to raise holdings of overseas investments to 30% by 2017 to boost returns.

Japan's elderly struggle to survive by CNN_International