Fallout From GPIF's New Asset Allocation?

Yoshiaki Nohara, Toshiro Hasegawa and Satoshi Kawano of Bloomberg report, Japan’s Pension Fund Cutting Local Bonds to Buy Equities:
Japan's public pension fund, the world’s biggest manager of retirement savings, said it will reduce its holdings of local bonds and buy more shares.

The proportion of assets held in Japanese bonds will be cut to 60 percent from 67 percent, the health ministry said yesterday in Tokyo at a briefing to announce changes to the mid-term plan of the Government Pension Investment Fund. The weighting of local shares will be increased to 12 percent from 11 percent currently. The Health and Welfare Ministry, which oversees pensions, didn’t give a time frame for the changes.

“It was a negative factor as far as bond supply and demand is concerned,” said Makoto Suzuki, a bond strategist at Okasan Securities Co. in Tokyo, one of the 24 primary dealers obliged to bid at government debt sales.

GPIF’s shift toward higher-yielding assets comes as it prepares to fund retirements in the world’s most elderly population and Prime Minister Shinzo Abe tries to revive the economy through fiscal and monetary stimulus. Domestic shares have slid since Abe said on June 6 that a legislative campaign to loosen rules on businesses, the “third arrow” of his economic plan, won’t begin for months.

Changes to GPIF’s asset allocation are effective from yesterday, fund official Masahiro Ooe told reporters. He declined to elaborate on the timing for completion of the portfolio changes.
Investing Abroad

Allocations to foreign bonds will rise to 11 percent from 8 percent, while overseas shares will increase to 12 percent from 9 percent, according to a document on GPIF’s website.

Nikkei 225 Stock Average futures in Chicago rose the most in two months last night, with the June contract gaining 4.1 percent to 13,240. The Nikkei 225 fell 0.2 percent in Tokyo yesterday to 12,877.53, while the broader Topix index slid 1.3 percent and is down about 17 percent from its May high.

GPIF, created in 2006, managed 112 trillion yen ($1.16 trillion) as of Dec. 31. It didn’t alter the structure of its holdings during the worst global financial crisis in 80 years or in response to Japan’s 2011 earthquake and nuclear disaster.

In an interview in February, GPIF President Takahiro Mitani the fund may have to reduce its bond holdings and buy alternative assets to cope with a higher interest-rate environment under Abe. After a review in April-to-May, any portfolio changes would begin in early 2014, he said at the time.
Yields Rise

Yields on 10-year Japanese government bonds increased 2 1/2 basis points to 0.86 percent in Tokyo, according to Japan Bond Trading Co. Futures on the notes recovered from a drop in the afternoon to close at 143.11 on the Tokyo Stock Exchange, the highest since May 10.

“The reaction we have seen in the futures market has been muted,” said Teruyoshi Sotome, a Tokyo-based senior bond strategist at Mizuho Securities Co., one of the 24 primary dealers obliged to bid at government auctions. “We shouldn’t forget the change in GPIF’s portfolio is going to take place over the long term. The announcement is not a declaration that they are going to increase foreign investments by large amounts going forward.”

Japanese households had 1,547 trillion yen in financial assets as of the end of December, according to Bank of Japan data. That compares with 32 trillion yen of debt securities and 106 trillion yen in equities and investments, the data show.
BOJ Buys

Even as GPIF reduces its allocation to JGBs, the Bank of Japan has stepped up purchases. The BOJ said in April it would double monthly buying of JGBs to more than 7 trillion yen, and in May said it would increase the frequency of the operations.

JGBs have lost about 1.64 percent so far this quarter, the most since the period ended September 2003, according to a Bank of America Merrill Lynch index.

Domestic bonds made up about 60 percent of GPIF’s assets at the end of December, according to a document on its website. The fund is amending its targets to bring them into line with the changing value of its holdings, said Hideo Shimomura, who helps oversee the equivalent of $62 billion in Tokyo as chief fund investor at Mitsubishi UFJ Asset Management Co., a unit of Japan’s largest publicly traded bank.

“They don’t have to touch their assets,” Shimomura said. “I don’t think this news could affect markets.”
Chikafumi Hodo of Reuters also reports, Japan's $1 trillion public pension cuts government bond weighting, lifts stocks:
Japan's public pension fund, the world's largest with a pool of $1.1 trillion, announced on Friday the most significant shift in its asset allocation since 2006 so it can take on greater risk by shifting into stocks and away from Japanese government bonds.

The steps by the Government Pension Investment Fund (GPIF) come after a draft strategy document this week showed Prime Minister Shinzo Abe was considering a push for public funds to increase returns as part of measures to revive the economy's fortunes. The events confirm reports by Reuters this week.

GPIF said it is increasing its Japanese stocks allocation to 12 percent of its portfolio from 11 percent, while lowering its JGB weighting to 60 percent from 67 percent. However, the change largely reflects adjustments already made in the portfolio, suggesting limited impact on markets.

The fund's latest publicly available allocations show that as of December 60.1 percent of the 111.9 trillion yen ($1.1 trillion) under management was already in JGBs. It had already allocated 12.9 percent to domestic stocks.

"GPIF is ratifying the current situation taking into account the moves in the market. GPIF would avoid readjusting its portfolio by doing this," said Eiji Dohke, director and chief JGB strategist at Citigroup Global Markets Japan.

GPIF said it would increase its weighting in foreign stocks to 12 percent from 9 percent and lift its allocation of foreign bonds to 11 percent from 8 percent.

The new allocations were released after the close of Tokyo share trading but expectations of the announcement had pushed stocks up from the day's low. The stock benchmark Nikkei average closed down 0.2 percent on the day.


Masahiro Ooe, a councilor at GPIF, told a news conference that a review of the fund's long-term risk and return profile had concluded the pension could take more risk.

The fund said it will not comment on whether it will trade actively in the market.

Dohke said the changes could still depress JGBs as hopes for GPIF inflows into JGBs could now have receded. Some in the market had thought the fund would have to sell domestic shares and foreign assets to maintain its investment limits and they had speculated some of the cash proceeds would then go into JGBS.

"But this is not likely to happen after today's change, Dohke said.

Government bonds will remain the fund's staple investment however, unlike some other large public funds globally which adopt a much greater weighting in stocks.

Canada's Pension Plan Investment Board, with $183 billion in assets, and Norway's $686 billion pool of government savings from petroleum revenue, known as the Government Pension Fund Global, both allocate most of their money to equities.

GPIF hit its own internal return targets in recent years, or a total return averaging 2.4 percent a year. By comparison, Norway's Government Pension Fund Global, returned almost 6 percent a year over the past decade.


A growth strategy outlined this week by Abe marked the first time he had sought to mobilize public savings to support an aggressive growth agenda aimed at defeating years of deflation and sluggish economic growth. GPIF and other Japanese public funds have a collective pool of $2 trillion in assets.

Abe has already pushed through $100 billion in government spending and shaken up monetary policy by prodding the Bank of Japan into a $1.4 trillion stimulus effort to achieve 2 percent inflation within two years.

He won a December election as leader of the Liberal Democratic Party and promised "bold" economic policies, which been dubbed 'Abenomics' by the media.

The Nikkei is up 24 percent this year off the back of Abe's policies, although a bout of profit taking has pulled the average back from its highs of the year.

"Recent weakness in the market represents a little bit of a disappointment for Abenomics," said Kenji Shiomura, an analyst at Daiwa Securities.

"But it would be too extreme to say that hopes for Abenomics have faded completely because the biggest impact Abenomics gave the market was monetary easing, and it is still continuing," he said.

The changes by the GPIF were prompted by a report from Japan's Board of Audit, which had been requested by Japan's upper house. The board called last year for the fund to review its targets and allocations.
GPIF's new asset allocation may not affect markets now but it created quite a stir when the story broke out early last week that GPIF is mulling a shift into equities. This was followed by news that the government of Japan is now targeting Japanese pension funds as part of its growth strategy.

What are the key takeaways for global asset allocators? First, global liquidity flows should continue to support risk assets and alternative investments. Second, Japan is exporting deflation and this will eventually force other central banks to respond to a weakening yen. Third, the Bank of Japan will have to step up its purchases of JGBs following the pension fund news.

The most important question is whether or not central bank policies will eventually lead to inflation or deflation down the road. The irony is that Japan's quest to conquer deflation is exporting deflation elsewhere at the worst possible time, endangering the global economic recovery.

Last week, I discussed whether the recent sell-off in bonds is for real, pointing out that while inflation expectations remain muted, global growth is driving bond yields higher. But if yields back up too much, too fast, it will wreak havoc on markets and Asia is particularly vulnerable to any abrupt shift in global bond yields.

One prominent Wall Street strategist who used to make bold calls at Merrill Lynch, Richard Bernstein, is now betting the U.S. will beat emerging markets, stating the following to Barron's:
People continue to overestimate the risks in the U.S. I would argue that they grossly -- and I'm not using that word lightly -- underestimate the risks in the emerging markets. A lot of the problems that people think are inevitably going to crop up here, including inflation and out-of-control money growth, are actually happening in the emerging markets. We aren't seeing those risks here. But the thinking is that it is inevitable and it has to happen here. A lot of people have talked about how the great rotation will be a shift from bonds to stocks. But that's not right. The great rotation -- and the biggest decision you have to make for your portfolio -- is that for five to seven years, it is not going to be bonds to stocks, but rather non-U.S. assets to U.S assets. We are maybe in the fourth inning of a secular period of outperformance for U.S. assets. Think about this: The Standard & Poor's 500 has outperformed emerging markets now for five years. Nobody cares, and it pains people to admit that the U.S. market has been outperforming.
...the hyperbolic credit creation in China has gotten worse, for example, and the money supply problems in India have gotten worse, as have the corporate fundamentals in China. The Chinese corporate sector is now one of the most levered in the world, and its marginal return on investment is going down. So the efficiency of that economy's credit is getting lower and lower. That's not healthy; that's not a growth story. Expectations are too high. In 2012's fourth quarter, just under 60% of emerging-market companies reported negative earnings surprises, compared with 28% in the U.S. And the corporate fundamentals in emerging markets continue to erode.
Bernstein is warning investors to shy away from large-cap multinationals relying on emerging markets and focus on the "American industrial renaissance," where they see small- and mid-cap industrial-manufacturing companies in the U.S. gaining market share. This is why he particularly likes smaller U.S.banks.

Bernstein is underweight energy and commodities for two reasons:
...one cyclical, the other secular. Starting with the cyclical: Energy and commodities are traditional late-cycle plays. Why? Because inflation is a late-cycle play. You need bottlenecks in the economy, and you need demand to outstrip supply. I don't care about all these guys who say inflation is imminent because the Fed is printing money. Demand must outstrip supply to get inflation. But we aren't late in the cycle. The Fed isn't tightening. The secular reason is that if you agree with us that emerging markets have been overstimulated by the global credit bubble, that explains the demand for commodities on a secular basis. Again, commodities are very credit-sensitive. I find it quite amazing that people will generally agree that the global credit bubble is deflating. But then they want to play credit-sensitive investments like energy and commodities and gold. That doesn't make a lot of sense.
Interestingly, Goldman Sachs and Citigroup Inc. predict the end of the decade-long bull market in commodities even as the global economy expands. And hedge funds' bullish bets on commodities are at a six week low, which tells you where sentiment lies. Still, if global growth heats up, commodities could bounce back strongly. Also worth noting that China's imports of major commodities all rose in May, even as overall imports weakened.

One thing is for sure, the slide in commodity prices has been a boon for resource-hungry firms' shares, keeping inflation expectations muted even as bond yields creep up. This supports continued strength in industrial, financial and technology shares going forward.

I started this comment discussing GPIF's new asset allocation and ended up talking about global asset alocation. There are many things happening all at the same time but the key thing to remember is the titanic battle over deflation has gone global and pension funds need to assess their asset allocation accordingly in this new environment, looking at how it will impact their public and private market portfolios around the world.

Below, John Mauldin, president of Millennium Wave Advisors, talks about the Japanese government's economic policies and outlook for the Japanese yen. Mauldin speaks with Tom Keene and Sara Eisen on Bloomberg Television's "Surveillance." Dan Clifton of Strategas Research Partners also speaks.