Monday, June 3, 2013

Japan's GPIF Mulls Shift Into Equities?

Chikafumi Hodo of Reuters reports, Japan public pension mulls shift after stock rally:
Japan's public pension fund - a pool of over $1 trillion - is considering a change to its portfolio strategy that could allow its investment in domestic stocks to grow with a rallying market, according to people familiar with the deliberations.

The changes, yet to be finalized, would mark the most significant revision in investment strategy for the world's largest pension fund since 2006 and highlight the game-changing economic policies of Prime Minister Shinzo Abe.

Without the shift, the Government Pension Investment Fund (GPIF) could be forced to buy Japanese government bonds, already the biggest part of its portfolio by far, in a weakening and more volatile market. It could also have to sell Japanese stocks in an equity market that has rallied more than 60 percent since November even after the recent sell-off.

The main idea under consideration would be for the pension fund to change the way it assesses the potential risk and return on assets to allow it more flexibility, the sources said. GPIF would keep its model portfolio, which sets a broad framework on how much money is allocated to different assets, unchanged.

The sources, who declined to be identified because they were not authorized to discuss the pending changes, said the fund is expected to announce the changes as soon as next month.

An official at GPIF declined to comment on the matter.

Abe's economic policies, dubbed Abenomics, are aimed at reviving the economy with 2 percent inflation, more consumer spending and corporate investment.

Tokyo stocks have rallied since Abe began pushing his policies ahead of his December election victory. At the same time, the yield on the 10-year Japanese government bond has risen to near 1 percent, ending a rally in the government debt market that began in 2006.

Those developments have created a problem for GPIF, according to the people familiar with fund's deliberations.

The fund's exposure to domestic bonds has dropped to near the bottom of the allowable limit under its established portfolio. At the same time, the allocations for overseas and domestic equities have neared their maximum limits.

So without changes, the fund would be forced to buy weakening bonds and sell rising stocks. GPIF has not detailed its current risk and return profile, but fund management have used such projections as a benchmark to ensure that the public fund is not overexposed to riskier and more volatile assets.

GPIF manages a $1.1-trillion dollar portfolio equivalent to the size of the annual economic output of Mexico from a non-descript brown skyscraper in Tokyo's Kasumigaseki district. The fund, which is responsible for the retirement savings of Japanese government employees, has relied on a portfolio model that includes a 67 percent allocation for domestic bonds.

Its investment model went unchanged through the global financial crisis of 2008 and served the fund well through the years of slow growth in Japan since.

For the six years through March 2012, the pension fund's investment in yen bonds had returned 2.28 percent. By contrast, domestic stocks lost 9.43 percent over the same period.

A committee of 10 outside advisers that serve as the fund's investment committee have been reviewing GPIF's strategy. The committee has met three times since April.

REVIEW UNDERWAY

GPIF Chairman Takahiro Mitani told Reuters in February that the public pension would review its long-term investment target and portfolio model, in part because it had already come under scrutiny by another public agency.

In October 2012, a report by Japan's Board of Audit had called on the pension fund to consider such a review. The board's 120-page report, which was commissioned by the then-ruling Democratic Party, questioned whether the GPIF portfolio targets remained relevant and whether they should be changed to better reflect considerations of investment risk.

The fund's long-term investment targets, reviewed every five years, must be approved by the health minister. The next review of that target is scheduled to start from next financial year in April 2014.

But GPIF is also allowed to change its investment targets during times of extraordinary market developments. The public fund reviewed its portfolio after the Lehman crisis in 2008 and the March 2011 earthquake and tsunami, but elected on both occasions to keep its targets unchanged.

But the sharp moves in financial markets over the past six months and the critical review by auditors have made fund administrators more serious about considering changes now, people familiar with the matter said.

The fund's model portfolio sets a core allocation of 67 percent for bonds, 11 percent for domestic stocks, 9 percent for foreign stocks and 8 percent for foreign bonds. The fund is allowed to keep allocations within a percentage range centered on those targets.

By the end of December, the fund was about 60 percent invested in domestic bonds, approaching its 59-percent minimum limit.

At the other extreme, it had about 13 percent in foreign equities, close to its allocation ceiling of 14 percent. GPIF had about 13 percent in Japanese equities in December compared to a ceiling of 17 percent.

The yield on the benchmark 10-year Japanese government bond was 0.9 percent on Thursday, compared with a dividend yield of almost 1.7 percent for the Topix.

GPIF is set to announce results for the January-March quarter in late June or early July.
Whenever Japan's giant pension fund mulls any shift out of JGBs into equities, markets take notice. The yen fell against the dollar on the proposed changes:
"The rationale behind the yen selling on the back of Japan's GPIF headlines seems linked the hedging behaviour of foreign investors buying Japanese stocks," said Valentin Marinov, head of European G10 FX strategy at Citi.

"If the headline is confirmed, it could fuel a renewed Nikkei rally and hence more demand for short-yen hedges by foreign investors. This could trigger more dollar/yen buying from here."

The yen is impacted when foreign investors buy Japanese equities because they hedge this investment by buying dollars against the yen.

The dollar had earlier slipped against yen on Thursday after faltering equities pushed market participants to opt for the safety of the yen and unwind their bets for a stronger dollar.

Most market participants expect the dollar to continue to gain against the yen over the medium term due to the Bank of Japan's aggressive monetary easing and that buyers would emerge on dips.

The euro was also up 0.6 percent against the yen at 131.67 yen.

Against the dollar, the euro was up 0.1 percent at $1.2952 after briefly breaking the $1.30 mark to hit a peak of $1.3006.

The single currency was also supported by data which signalled an improvement in economic sentiment in the euro zone.

But strategists said there was still a chance of a rate cut by the European Central Bank and this could hurt the euro.

"If euro area economy deteriorates people will take a closer look at the likelihood the ECB will cut rates and that will drive the euro lower," said Paul Robson, currency strategist at RBS.

Strategists also said the dollar would find support on prospects the U.S. Federal Reserve might taper its current $85 billion-a-month stimulus programme in coming months.

"Quantitative easing tapering cannot be ruled out later this year and that is going to continue to support the dollar... we won't see a trend reversal lower in the dollar," Citi's Marinov said.
On a macro level, I agree with Randall Forsyth of Barron's who back in April noted  the steep decline in the yen means Japan's new export is deflation:
As Richard Koo, chief economist of the Nomura Research Institute details in his latest research report, past Bank of Japan programs of "quantitative easing"—the large-scale purchase of securities by the central bank—have not produced economic growth. That's even though the Bank of Japan's expansion of its balance sheet has been proportionately bigger than the Federal Reserve's or the Bank of England's, he notes.

In the case of Japan, the central bank's securities purchases—which inject liquidity into the financial system—have failed to produce a similar expansion of the money supply. That requires an increase in bank lending, which hasn't happened either because of banks' reluctance to lend or borrowers' reluctance to borrow. Koo pins the problem on the latter in a balance-sheet recession, where businesses and consumers are more apt to shed debt than take it on—even at interest rates of virtually zero.

As a result, the impact of the Bank of Japan's actions so far mainly has been felt in the currency markets, not the credit markets. Moreover, despite the prospect of heavy, continued purchases of Japanese government bonds by the central banks, JGB yields have been bouncing higher. Again, precisely the opposite of the planned outcome predicted in the textbooks.

Japan's actions mainly have worked to lower the yen, which in turn raises the exchange rate of the currencies of its export competitors around the globe. In effect, that is a tightening of monetary policy for everybody else—at a time that global growth is slowing. Viewed from that perspective, no wonder gold is being battered.
Interestingly, the biggest monthly loss in fixed-income securities since 2004 has left global yields short of the tipping point that would signal a bear market in bonds. Clearly many are worried about Japan being the canary in the coal mine, but these inflation concerns are overblown.

John Mauldin wrote an excellent comment over the weekend, Central Bankers Gone Wild, where he states the "Bank of Japan is on its way to becoming the market for Japanese bonds," and along with increasing exports of cars, flat-panel screens, robots, and machine tools, Japan is going to try and export the one thing it has in abundance that the world does not want: deflation.

And this is why I believe it's only a matter of time before the ECB also engages in massive quantitative easing and that the Fed will not significantly taper its quantitative easing later this year. Central bankers will fight deflation with everything they have, which will translate into more volatility in stock, bond, currency and commodity markets. 

Against this background, GPIF and other Japanese pension funds are struggling with their asset allocation decisions. They are way too exposed to domestic debt but shifting into equities will introduce more volatility in their funds. Japanese pensions are moving into alternatives but this is a very small part of their asset allocation.

Below, Citigroup's Valentin Marinov comments on the state of the Japanese economy and his currency strategy. He speaks with Mark Barton and Anna Edwards on Bloomberg Television's "Countdown."

And Ramin Toloui, Singapore-based global co-head of emerging markets portfolio management at PIMCO, talks about the outlook for China's economy, stocks and his investment strategy. Toloui speaks in Hong Kong with Susan Li and Rishaad Salamat on Bloomberg Television's "Asia Edge."