Awakening Japan's Sleeping Giant?

Chikafumi Hodo of Reuters reports that Japan's public pension fund urged to seek higher returns:

A Japanese government minister on Friday urged the country's massive public pension fund to seek higher returns, ramping up pressure on the traditionally conservative investment portfolio to take more risk.

The size of the $1.36 trillion public pension fund, the world's largest, is greater than the 2008 gross domestic products of countries including Australia, India and Mexico, and is almost seven times bigger than top U.S. pension fund CalPERS.

Internal Affairs Minister Kazuhiro Haraguchi told reporters at a news conference after a health ministry panel meeting that the Government Pension Investment Fund (GPIF) should seek greater returns than it has generated in the last few years.

He urged a review of the fund's performance after the rate of return on its investments fell to minus 10.3 percent, or a record loss of 9.7 trillion yen ($108 billion), in the financial year that ended in March 2009.

The GPIF has boasted that its conservative strategy, under which nearly 70 percent of its assets are held in Japanese government bonds, helped limit its losses compared to foreign pension funds that year.

Haraguchi declined to comment on how the GPIF should set up its portfolio, however, as his views could impact markets.

The internal minister also said there should be a review of whether it is appropriate for a lone person, the GPIF president, to give the final approval for the fund's asset allocation and also whether a single body should manage such an enormous fund.

"We need to verify whether it is appropriate for only one organisation to manage such a huge fund of more than 120 trillion yen," Haraguchi said.

But Health Minister Akira Nagatsuma, who supervises the fund, said it should stick to safe investments.

Nagatsuma said in a speech at the meeting that the U.S. public pension fund is even more conservative than the GPIF as it only invests in Treasury bonds.

Haraguchi's internal affairs ministry oversees the country's independent administrative institutions, or semi-government agencies, such as the GPIF.

MASSIVE PORTFOLIO

The GPIF manages its fund in line with a model portfolio, which is reviewed every five years based on a return target given by the health ministry.

The health ministry panel is currently drawing up a new investment target, which is scheduled to be given to the public fund in February or March, a health ministry official said.

The GPIF is set to manage their funds under the new model portfolio from April.

Domestic bonds currently make up 67 percent of the public fund's portfolio, domestic stocks comprise 11 percent, foreign stocks 9 percent and foreign bonds 8 percent.

Analysts said the GPIF's portfolio is too big for a drastic allocation change, but that there is a need for the public fund to be more transparent.

The current procedure for determining asset allocation involves both the health ministry and the GPIF, making it difficult to pinpoint who is responsible for its performance, analysts said.

"Its portfolio is so enormous that any changes in its investment strategy could move markets, so it is understandable that there is an argument for restructuring," said Takahiro Tsuchiya, a strategist at the Daiwa Institute of Research.

"But whether such a move is possible is open to question as it would cost a lot," Tsuchiya continued.

My advice to Japanese authorities is to break up this giant fund and set up a more diversified asset allocation with tight governance rules that limit the downside risk. If you invest in hedge funds, set up managed accounts where you can pull the plug at any time. There are a few knowledgeable advisors you can work with to set this up. If you diversify into private equity and real estate, be careful and once again, choose your partners wisely.

What will an asset allocation move from Japan's sleeping giant mean for the markets? Probably nothing in the near term, but over the longer term, this will add to the liquidity tsunami and direct investments into stocks, hedge funds, private equity funds can potentially impact markets in a profound way.