Thursday, July 26, 2012

Can Japan's GPIF Solve its Funding Problems?

Institutional Investor reports, Can Japan's Government Pension Solve its Funding Problems?:

THE AIR INSIDE THE GOVERNMENT PENSION FUND'S Tokyo headquarters was as warm and dry as a spaceship’s. As president Takahiro Mitani and his colleagues filed silently into an austere meeting room, I was sweating slightly, struggling to compose my question with the correct level of Japanese politesse: “How did the world’s largest pension fund decide on such a conservative level of risk and return for its portfolio?”

It was far from an idle question. The GPIF has ¥108 trillion ($1.36 trillion) in assets under management. That’s nearly six times as much as the California Public Employees’ Retirement System, the biggest U.S. pension fund, and nearly four times as much as Europe’s largest pension plan, Stichting Pensioenfonds ABP of the Netherlands. Even more striking than the fund’s gargantuan size is its composition: Fully three quarters of the GPIF is invested in bonds, including ¥58.4 trillion of domestic bonds and ¥14.4 trillion of government agency debt.

Many large Western pension funds, led by pioneers like Cal­PERS and ABP, have chosen to reach for yield, a choice they know exposes them to big market swings. For some of these funds, the portfolio losses of 2008–’09 were near-death experiences (CalPERS’s assets plunged 38 percent), pushing their funding ratios down into the red zone. Yet most of these funds are trying to grow their way out by continuing to bet heavily on equities and making ever-larger allocations to private equity, hedge funds, real estate, infrastructure and other illiquid assets.

But not the GPIF. At the end of 2011, the Japanese fund had 67.4 percent of its portfolio invested in Japanese bonds, 11.1 percent in Japanese stocks, 8.4 percent in foreign bonds, 10.1 percent in foreign stocks and 3 percent in short-term assets. No exotic long-dated assets anywhere. And fully 80 percent of the portfolio is invested passively.

The GPIF’s financial conservatism is all the more striking considering its demographic challenge: Japan is starting to slide down the reverse slope of an inexorable demographic curve. Forecasts by the country’s National Institute of Population and Social Security Research estimate that the number of people between 15 and 64 years old will nearly halve in the next 50 years, to 44.2 million in 2060 from 81.7 million in 2010, even as the number of retirees swells.

Japan’s public pension system was basically a pay-as-you-go defined benefit plan until the past decade, when Tokyo created the GPIF and began a series of incremental reforms designed to put the country’s pension system on a more sustainable basis, such as increasing contribution rates and reducing benefits. Those measures fall well short of what’s needed to ensure that the GPIF will be able to redeem the promises made to today’s workers, though. Already, the fund is paying out more in pension benefits than it receives in contributions, an inflection point it passed in 2009.

The twin problems of government deficits and demographic decline have seized center stage in Japan’s policy debate. All eyes are on the GPIF and its massive pot of money, to see whether the fund can generate adequate returns on its portfolio. This debate highlights several policy trade-offs of deep interest to pension funds, money managers and Treasury and Finance Ministry officials in North America and Europe, where countries face the same dilemma of demographic pressures and underfunded pension schemes. How Japan resolves its debate is bound to shape global financial markets in a profound way.

Hence my trek to see Mitani-san. Why did the GPIF make its conservative portfolio strategy choice? What political factors got it there, and what governance structures keep it there? Who makes money from the GPIF’s strategy, and who might profit — or lose — from a shift in the fund’s risk-reward profile? These were just a few of the questions I hoped to get answers to.

Those of you who want to read the rest of the article can do so by clicking here. It's clear that Japan's giant pensions will face the same funding pressures putting pressure on global pensions to hunt for yield.

Monami Yui and Yumi Ikeda of Bloomberg report, World’s Biggest Pension Fund Sells JGBs to Cover Payouts:
Japan's public pension fund, the world’s largest, said it has been selling domestic government bonds as the number of people eligible for retirement payments increases.

“Payouts are getting bigger than insurance revenue, so we need to sell Japanese government bonds to raise cash,” said Takahiro Mitani, president of the Government Pension Investment Fund, which oversees 113.6 trillion yen ($1.45 trillion). “To boost returns, we may have to consider investing in new assets beyond conventional ones,” he said in an interview in Tokyo yesterday.

“Payouts are getting bigger than insurance revenue, so we need to sell Japanese government bonds to raise cash,” said Takahiro Mitani, president of the Government Pension Investment Fund, which oversees 113.6 trillion yen ($1.45 trillion). “To boost returns, we may have to consider investing in new assets beyond conventional ones,” he said in an interview in Tokyo yesterday.

Japan’s population is aging, and baby boomers born in the wake of World War II are beginning to reach 65 and become eligible for pensions. That’s putting GPIF under pressure to sell JGBs to cover the increase in payouts. The fund needs to raise about 8.87 trillion yen this fiscal year, Mitani said in an interview in April. As part of its effort to diversify assets and generate higher returns, GPIF recently started investing in emerging market stocks.

GPIF is historically one of the biggest buyers of Japanese debt and held 71.9 trillion yen, or 63 percent of its assets, in domestic bonds as of March, according to the fund’s financial statement for the 2011 fiscal year. That compares with 13 percent in domestic stocks, 8.7 percent in foreign bonds and 11 percent in overseas equities.

Emerging Stocks

The fund named six institutions including Nomura Asset Management Co. and Mizuho Asset Management Co. to manage its emerging market stocks portfolio, according to a statement on its website earlier this month. The investments will be focused on countries in the MSCI Emerging Markets Index (MXEF), which tracks 21 nations including Brazil, Russia, India, China, South Korea, Taiwan and South Africa.

“We started with a small amount very recently,” Mitani said yesterday, without elaborating.

Mitani also declined to say whether the fund’s performance since April is matching last year’s total return of 2.32 percent. “Our performance is not that good so far this year due to the yen’s strength and losses in domestic and overseas stocks,” he said.

The market environment may remain “favorable” for Japan’s debt over the next couple of years on prospects that the Bank of Japan will keep easing monetary policy to meet its 1 percent inflation goal, according to Mitani.

GPIF is the biggest pension fund in the world by assets under management, according to the Towers Watson Global 300 survey in September, followed by Norway’s government pension fund.

Bond Yields

The yield on 10-year Japanese government notes climbed one basis point, or 0.01 percentage point, to 0.73 percent as of 10:30 a.m. in Tokyo. The rate closed at 0.72 percent yesterday, matching the lowest level since June 2003, when it fell to a record 0.43 percent. Bonds with a maturity of up to three years all yield about 0.1 percent as the central bank buys these securities through its asset-purchase program.

The prolonged debt crisis in Europe has added to demand for yen-denominated assets, sending the currency to 77.94 per dollar this week, the strongest since June 1. Against the euro the yen reached 94.12, a level unseen since November 2000.

“There isn’t much value in short-term notes as the BOJ’s massive asset purchases have made their yields extremely low,” said Mitani. “I would say the current 0.7 percent level for 10- year yields is a bit too low, because we have to take into account that there are flight-to-quality bids in JGBs because of the European crisis.”

Recently, Japan's Government Pension Investment Fund dipped its toe in emerging markets, selecting six asset managers to make its first investments in that region as it tries to boost returns in the face of rising payout obligations.

Fox Business reports that the giant pension fund is facing increased scrutiny at home:

The Labor and Welfare Ministry has begun an organizational review of Japan's biggest public pension fund, seeking to weaken the chief executive's authority and increase national oversight, The Nikkei reported early Wednesday.

The Government Pension Investment Fund had 113 trillion yen in assets under management at the end of March. It is run by a president and an executive managing director, who are watched over by two auditors. An in-house investment committee offers advice, but the president has the final word on investment and operating decisions. Critics say this structure impedes external oversight.

A Labor Ministry panel took up the issue Tuesday and intends to report on its review by year-end. Legislative changes would follow next year.

Ministry officials say the president has too much discretion over the GPIF's vast pool of assets. The ministry wants to reorganize the fund's management to create multiple angles for oversight. Among the ideas to be considered is a corporate-boardroom-style governance model, where multiple directors make decisions in concert.

The review won't address the fund's investment strategy, which has a major impact on the long-term stability of the pension system. Not everyone on the panel agrees with that decision.

"Unless it's clear whether the fund aims for high-return investment or reduced-risk investment, it will be difficult to discuss organizational changes," said Shigeru Kojima, a researcher with the Rengo labor union confederation's Research Institute for Advancement of Living Standards.

I find it interesting that so much power is concentrated in such few hands at the world's largest pension fund but they seem to be doing just fine. Investing in JGBs shielded them from serious market downturns.

But now there are increasing calls to start looking outside to realize the target return they require, and investing in JGBs won't cut it. Keep an eye on this giant pension as it may slowly morph into another global pension powerhouse that invests in traditional and alternative assets.

Below, European Central Bank President Mario Draghi signaled that officials are prepared to do whatever is needed to preserve the euro and act on surging bond yields that are tearing at the seams of the 17-nation currency bloc.

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