Thursday, March 19, 2015

Will Japan's Pensions Save Abenomics?

Eleanor Warnock of the Wall Street Journal reports, Japan Pension Funds Announce Portfolio Shift:
Three Japanese public pensions said Friday that they plan to shift more money into equities from domestic government bonds, following a similar move by the nation’s $1.1 trillion Government Pension Investment Fund.

The three funds control a combined ¥30 trillion yen ($249 billion), an amount roughly the size of Greece’s gross domestic product. They will adopt the same portfolio as the GPIF, according to a statement on the GPIF’s website.

The GPIF, the world’s largest pension fund, has been shifting assets to domestic and overseas equities since last year. Its reallocation—and expectations that other Japanese pension funds would follow suit—have helped push Tokyo’s Nikkei Stock Average to a 15-year high this week.

The moves into riskier assets come at the urging of Prime Minister Shinzo Abe, who hopes to secure higher returns for pension funds faced with a rapidly aging population while helping to reinvigorate financial markets.

The three smaller pensions’ decision to use the GPIF’s portfolio as a model reflects a 2012 law that mandates the consolidation of the nation’s employee pension system by October 2015. Though the funds will align their investment strategies, they will still be organizationally independent, welfare minister Yasuhisa Shiozaki said earlier this month.

The three smaller funds also hold assets that the GPIF doesn’t have, including real estate and educational and home loans to members. They will treat any such assets as either stocks or bonds, the statement said.

Data indicate the three smaller pensions have already started to shift their portfolios. Trust banks, which manage money for pensions, sold a net ¥389.1 billion of super-long Japanese government bonds in February, the sixth consecutive month of net selling, according to data released Friday by the Japan Securities Dealers Associations. Pensions are big investors in super-long JGBs as they invest over a long time horizon.

Strategists at JPMorgan Securities Japan Co. said in a note earlier this month that the three pension funds adjusting their portfolios in line with the GPIF’s would create ¥7.2 trillion in sales of domestic bonds, ¥2.5 trillion in purchases of domestic stocks, ¥1.6 trillion of foreign bond purchases and ¥3.1 trillion in foreign equities purchases.

The GPIF, which manages money for Japan’s national pension system and for private-sector employees, said in October that it would cut its allocation to domestic bonds by nearly half to 35%. The fund raised allocations to domestic and foreign stocks and foreign bonds to 25%, 25% and 15%, respectively.

The three smaller funds are the Promotion and Mutual Aid Corporation for Private Schools of Japan, which had ¥3.8 trillion in pension assets at the end of the fiscal year ended in March, 2014, the Pension Fund Association for Local Government Officials, with ¥18.9 trillion, and the Federation of National Public Service Personnel Mutual Aid Associations with ¥7.3 trillion.

The association for national public servants announced in February that it had decided upon target asset allocations that matched the GPIF’s.

Representatives for the other three funds declined to comment.
Takashi Umekawa of Reuters also reports, Japan public pensions to follow GPIF into stocks from JGBs:
Three Japanese public pension funds with a combined $250 billion in assets will follow the mammoth Government Pension Investment Fund and shift more of their investments out of government bonds and into stocks, two people involved in the decisions said.

The three funds and the trillion-dollar Government Pension Investment Fund, the world's biggest pension fund, will announce on Friday a common model portfolio in line with asset allocations recently decided by the GPIF, the people told Reuters.

Assuming, as expected, the three smaller mutual-aid pensions adopt the portfolio, that would mean shifting some 3.58 trillion yen ($30 billion) into Japanese stocks, a Reuters calculation shows.

The GPIF in October slashed its targeted holdings of low-yielding government bonds and doubled its target for stocks, as part of Prime Minister Shinzo Abe's plan to boost the economy and promote risk-taking.

GPIF in October slashed its targeted holdings of low-yielding government bonds and doubled its target for stocks, as part of Prime Minister Shinzo Abe's plan to jolt Japan out of two decades of deflation and fitful growth and promote risk-taking.

The shift to riskier investments by the 137 trillion yen ($1.1 trillion) GPIF has helped drive Tokyo Stocks to 15-year highs this week because of the fund's size and because it is seen as a bellwether for other big Japanese institutional investors.

The new model portfolio, part of a government plan to consolidate Japan's pension system in October, will match the new GPIF allocations of 35 percent in Japanese government bonds, 25 percent in domestic stocks, 15 percent in foreign bonds and 25 percent in foreign stocks, the sources said.

Final investment amounts may vary, as the three funds are not required to follow the model and they, like GPIF, will have some leeway above and below their targeted levels to manage their portfolios in practice, the sources said.

The smaller funds will also have latitude to keep some of their assets in cash, which GPIF no longer does, the sources said.

Shinichiro Mori, head of GPIF's Planning Division, said nothing has been decided about the model portfolio.

Spokesmen for the other funds - the 18.9-trillion-yen Pension Fund Association for Local Government Officials, the 7.6-trillion-yen Federation of National Public Service Personnel Mutual Aid Association and the 3.8-trillion-yen The Promotion and Mutual Aid Corporation for Private Schools of Japan - declined to comment on their asset-allocation plans.
I've been covering the 'seismic shift' in Japan since November 2012. Interestingly, Japan is pulling its own version of Operation AIG, throwing everything it's got to tackle its deflation dragon. More QE, more government spending and more risk taking by GPIF and other public and private pensions.

Will it work? I strongly doubt it. Japanese authorities are trying to change perceptions by using pension savings to promote risk-taking behavior, but all they're doing is throwing money at a deep structural problem that won't magically disappear.

Earlier this week, Mehreen Khan of the Telegraph reported, Japan will struggle to slay deflation warns Bank governor:
The Japanese economy is in danger of slipping back into deflation despite two years of intensive monetary action, the country's central bank governor has warned.

Haruhiko Kuroda, head of the Bank of Japan, said the falling price of oil would push consumer prices back into negative territory later this year.

"Depending on oil price moves, we can't rule out the possibility that core consumer prices will fall slightly year-on-year," said Mr Kuroda.

Core consumer inflation, which is the central bank's preferred measure, currently stands at 0.2pc, well below the mandated 2pc target. Prices are now "moving to around zero percent for the time being on declines in energy prices" cautioned the Bank of Japan.

Despite the downgrade to inflation expectations, the central bank decided to hold interest rates but continue with its aggressive quantitative easing programme.

"There's absolutely no change to our stance of aiming to achieve our 2pc inflation target at the earliest date possible with a timeframe of roughly two years," said Mr Kuroda, who will mark two years in office this week.

The country launched one of the most radical experiments in monetary policy last year, carrying out asset purchases worth 80 trillion yen (£444bn) a year in a bid to revive growth and flagging prices.

But there are doubts that the central bank will be able to stoke inflation amid weak global demand and collapsing energy prices.

April's headline inflation numbers are likely to take a further plunge as they will include the effects of a higher sales tax, warn Capital Economics.

"Risks will be mounting that the Bank’s success in lifting expectations of future price rises gets undermined," said Marcel Thieliant, economist at Capital Economics.

Economists think the weak inflationary outlook could force the BoJ into intensifying Japan's QE programme, to 90 trillion yen-a-year. But any decision to ramp up the stimulus could face opposition within the bank.

Three of the BoJ's monetary policy members voted against the decision to increase asset purchases last autumn. Mr Kuroda would need to convince a majority of his Board that more easing is necessary to approve the measure.

"Given that Japanese stocks are doing well, there's no need to ease policy now," said Hiroaki Muto, senior economist at Sumitomo Mitsui Asset Management.

"However, the BoJ will probably have to push back its two-year timeframe when it updates its forecasts in October, which will raise questions about monetary easing," said Mr Mitsui.

The Yen has weakened by 22pc since the government of Shinzo Abe began a policy of fiscal stimulus accompanied by radical monetary easing. Japan's QE blitz has led to fears of a "currency war" in Asia.
There are other reasons why I'm concerned about using Japan's large pensions as an extension of monetary and fiscal policy. First, it's terrible governance. In late February, Reuters reported that GPIF's governance overhaul bogs down amid resistance:
Japan's prime minister's office has baulked at a proposal to create a large board to oversee the country's $1.1 trillion pension which could delay attempts to improve its governance as it increasingly moves into riskier assets, according to sources and draft legislation seen by Reuters.

The Government Pension Investment Fund (GPIF) last year cut its allocations for low-yielding government bonds and doubled its target for stocks, a key element of Prime Minister Shinzo Abe's agenda to jump-start the long-sluggish economy, boost returns for millions of pensioners and spur risk-taking.

But five months after those changes helped boost Tokyo stocks, the dispute over the fund's governance is endangering the prospects for a governance bill, being prepared by the Ministry of Health, Labour and Welfare, to bolster oversight of the world's largest pension fund.

The bill, championed by Welfare Minister Yasuhisa Shiozaki, would put the fund under the management of a committee of up to 10 members, modelled on the board of directors of the Bank of Japan.

They would get broad powers as final judges on how the fund invests its 130 trillion yen in assets, the previously undisclosed draft shows.

The massive fund manages reserves of national and employee pension plans covering 67 million people, but hired its first chief investment officer only last July and has roughly 80 employees. Most of its investments are managed by outside fund managers.

Shiozaki and other reformers "believe that a more professional GPIF could not only deliver better returns for pensioners, but could also serve as a powerful activist investor, pressuring Japanese companies to improve their return on equity," said analyst Tobias Harris at Teneo Intelligence.

But the Prime Minister's Office has pushed back, essentially stalling Shiozaki's bill, on the grounds that GPIF needs a nimbler structure with more streamlined decision-making, said two people briefed on the matter.

"People in the ministry are still working on the draft, but the sense is that they are unlikely to get the green light to submit it to this session of parliament," said a person briefed on the process. That would mean the reform would be delayed until at least the autumn.

Chief Cabinet Secretary Yoshihide Suga, asked about potential delays to the bill, said this week the government should move ahead with what steps it can as they are ready "and move ahead with a sense of speed."

Abe's cabinet on Tuesday approved a separate, smaller measure that would add a senior GPIF executive and rescind a previous plan to move the fund's headquarters to Yokohama from Tokyo.

"The reform plan is still being debated at the relevant ministerial committee," said Hiyoshi Kai, an official at the ministry's pension department. "It's hard to say if it's going to be submitted in this session of parliament."
I guess all that talk about focusing on governance first was thrown right out the window. It's too bad because GPIF is the biggest pension fund in the world and without proper governance, modeled after the CPPIB, you leave it vulnerable to mediocre performance, not to mention corruption and unwise government interference (which is what's going on right now).

I have other concerns with Abenomics and using pensions to inflate risk assets. Yuriko Koike, Japan's former defense minister and national security adviser and former Chairwoman of Japan's Liberal Democratic Party's General Council, wrote an excellent comment for Project Syndicate, Thomas Piketty’s Japanese Tour:
Six months after Thomas Piketty's book Capital in the Twenty-First Century generated so much buzz in the United States and Europe, it has become a bestseller in Japan. But vast differences between Japan and its developed counterparts in the West, mean that, like so many other Western exports, Piketty's argument has taken on unique characteristics.

Piketty's main assertion is that the leading driver of increased inequality in the developed world is the accumulation of wealth by those who are already wealthy, driven by a rate of return on capital that consistently exceeds the rate of GDP growth. Japan, however, has lower levels of inequality than almost every other developed country. Indeed, though it has long been an industrial powerhouse, Japan is frequently called the world's most successful communist country.

Japan has a high income-tax rate for the rich (45%), and the inheritance tax rate recently was raised to 55%. This makes it difficult to accumulate capital over generations – a trend that Piketty cites as a significant driver of inequality.

As a result, Japan's richest families typically lose their wealth within three generations. This is driving a growing number of wealthy Japanese to move to Singapore or Australia, where inheritance taxes are lower. The familiarity of Japan, it seems, is no longer sufficient to compel the wealthy to endure the high taxes imposed upon them.

In this context, it is not surprising that Japan's “super-rich" remain a lot less wealthy than their counterparts in other countries. In the US, for example, the average income of the top one percent of households was $1,264,065 in 2012, according to the investment firm Sadoff Investment Research. In Japan, the top 1% of households earned about $240,000, on average (at 2012 exchange rates).

Yet Japanese remain sensitive to inequality, driving even the richest to avoid ostentatious displays of wealth. One simply does not see the profusion of mansions, yachts, and private jets typical of, say, Beverly Hills and Palm Beach.

For example, Haruka Nishimatsu, former President and CEO of Japan Airlines, attracted international attention a few years ago for his modest lifestyle. He relied on public transportation and ate lunch with employees in the company's cafeteria. By contrast, in China, the heads of national companies are well known for maintaining grandiose lifestyles.

We Japanese have a deeply ingrained stoicism, reflecting the Confucian notion that people do not lament poverty when others lament it equally. This willingness to accept a situation, however bad, as long as it affects everyone equally is what enabled Japan to endure two decades of deflation, without a public outcry over the authorities' repeated failure to redress it.

This national characteristic is not limited to individuals. The government, the central bank, the media, and companies wasted far too much time simply enduring deflation – time that they should have spent working actively to address it.

Japan finally has a government, led by Prime Minister Shinzo Abe, that is committed to ending deflation and reinvigorating economic growth, using a combination of expansionary monetary policy, active fiscal policy, and deregulation. Now in its third year, so-called “Abenomics" is showing some positive results. Share prices have risen by 220% since Abe came to power in December 2012. And corporate performance has improved – primarily in the export industries, which have benefited from a depreciated yen – with many companies posting their highest profits on record.

But Abenomics has yet to benefit everyone. In fact, there is a sense that Abe's policies are contributing to rising inequality. That is why Piketty's book appeals to so many Japanese.

For example, though the recent reduction in the corporate-tax rate was necessary to encourage economic growth and attract investment, it seems to many Japanese to be a questionable move at a time when the consumption-tax rate has been increased and measures to address deflation are pushing up prices. To address this problem, the companies that enjoy tax cuts should increase their employees' wages to keep pace with rising prices, instead of waiting for market forces to drive them up.

Herein lies the unique twist that Piketty's theory takes on in Japan: the disparity is not so much between the super-rich and everyone else, but between large corporations, which can retain earnings and accumulate capital, and the individuals who are being squeezed in the process.
She hits the nail on its head but there is another twist she neglects to mention. Japan's mammoth pensions are being used to buy domestic shares of companies which will undoubtedly make corporations and those that run them even richer, further fueling inequality. To be sure, it's nothing compared to the gross excesses of corporate America where CEO pay is spinning out of control but it's a form of wealth redistribution that needs to be openly discussed.

Anyways, I remain highly skeptical on using Japan's large public and private pensions to slay the deflation dragon. Pensions should not be used as an extension of monetary and fiscal policy. They are pooled savings of people who contribute expecting to retire in dignity and security. So on this front, I'd give Abenomics a categorical failing grade.

However, I agree with Thomas Piketty, Europe should learn from Japan that monetary policy alone can’t prevent the economy entering deflation and that other measures are needed. One of those measures is to raise wages for workers so they have more disposable income to spend on goods and services (see the clip below).

In theory, this will help as long as rising inequality and high inflation doesn't hit them. For now, this doesn't seem to be the problem as the country is still struggling to get out of a long deflationary cycle. But as Japan's giant pensions start taking on more risk, it could come back to haunt the country in ways nobody thought possible. This is why I urge Japanese policymakers to get the governance on GPIF and other large public pensions right and let them operate at arm's length from the government.

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