Abenomics Targets Japan's Pension Funds?
Japan's government is set to urge the nation's public pension funds - a pool of over $2 trillion - to increase their investment in equities and overseas assets as part of a growth strategy being readied by Prime Minister Shinzo Abe, according to people with knowledge of the policy shift.Ben McLannahan of the Financial Times also reports, Abe to press pension funds to invest more in Japanese stocks:
The steps, which could be announced as soon as Wednesday, represent the first time the Abe administration has looked to mobilize Japan's massive pool of savings to support a growth agenda that aims to spur more consumer spending and corporate investment by pushing the economy toward 2 percent inflation.
It also suggests a new element of risk to the policies known as Abenomics since it would shift funding from the government to the private sector at the risk of driving interest rates higher.
Specifically, the government will set up a panel in July to consider the investment strategies of public funds, which, like other Japanese institutional investors, have relied heavily on investment in Japanese government bonds in recent years.
The panel review will be included as part of a package of steps intended to boost growth set to be announced on Wednesday, according to the people with knowledge of the preparations who asked not to be named because an announcement has not been made.
The panel will look to reach a conclusion as soon as this autumn on strategy and will urge implementation of the new investment guidelines by public funds no later than April 2015, according to the sources.
As part of its deliberations, the panel will consider steps to allow the public funds to invest in alternative investments, including infrastructure financing both in Japan and abroad, the sources said.
The more aggressive investment strategy would apply to the Government Pension Investment Fund, known as GPIF, and about 100 other semi-governmental funds and public funds such as Federation of National Public Service Personnel Mutual Aid Associations, known as KKR.
In recent years, Japanese public funds led by GPIF have followed a conservative strategy that has meant a large allocation of funds to the Japanese government bond market and made them a near-captive source of financing for government spending.
GPIF, for instance, manages a portfolio that includes a mid-point target of a 67-percent allocation for domestic bonds, 11 percent for domestic stocks, 9 percent for foreign stocks and 8 percent for foreign bonds.
GPIF IN FOCUS
Abe has unleashed fiscal and monetary stimulus to boost growth in the short-term. But at the same time, officials have taken steps to reassure investors that Japan will tackle a public debt that is the biggest in the developed world at more than twice the size of the nation's annual economic output.
A government advisory panel warned last month that there was "no guarantee" that domestic investors would keep financing the nation's massive public debt, saying such a move could drive interest rates higher and crimp long-term growth prospects.
Reuters reported last week that GPIF has already been considering change to its portfolio strategy that could allow its investment in domestic stocks to grow with a rallying market. The fund manages the national pension and pension insurance for the private sector.
The Reuters report sent both the dollar higher against the yen and Nikkei futures higher as investors reacted to the prospect that the world's largest public pension fund could increase its exposure to assets other than domestic bonds.
The new government panel will review the investment strategies of public funds more generally, including steps to diversify portfolios and to establish a structure to improve risk management.
Japan's Health Ministry currently supervises the investment strategies of public pension funds.
GPIF's 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.
But more recently, the public pension's allocations have been bumping up against the established limits under its conservative portfolio.
By end-December, the public fund was about 60 percent invested in domestic bonds, approaching the minimum 59 percent limit. It had about 13 percent in foreign equities, close to its allocation ceiling of 14 percent.
The main idea under consideration would be for GPIF to change the way it evaluates the potential risk and return on assets to allow it more flexibility, sources have said.
Although Tokyo markets have turned volatile, 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.
More recently, stocks have fallen back from their highs and yields have retreated on the benchmark 10-year bond.
The Nikkei fell 3.7 percent to a six-week low on Monday and the 10-year yield slipped to 0.805 percent.
Shinzo Abe will call on Japan’s giant pension funds to lift their allocations to domestic stocks and to take a more active approach to investment, as the prime minister seeks ways to sustain new-found interest in the world’s second-biggest equity market.In my last comment, I covered why GPIF is mulling a shift into equities, going over the risks of inflation and deflation that come from such a shift as central banks respond to limit the damage of a falling yen.
As part of a new national growth strategy to be outlined at the end of next week, the Government Pension Investment Fund and other big institutional investors will be urged to lift automatic caps on their equity holdings while exercising their voting rights more frequently, according to a senior government official.
In theory, such moves could support prices by tipping the balance of supply and demand in the equity market, given the sheer size of the institutions concerned. Total assets at the GPIF, for example, stood at Y112tn ($1.1tn) at the end of December – about the same size as the economies of Mexico or South Korea – with a 60 per cent weighting to domestic bonds.
At the same time, the extra scrutiny from powerful domestic investors could encourage companies to pay more attention to returns to shareholders. Forecast ROEs for the biggest companies on the Topix index this year are about 9 per cent, well below the 15 to 20 per cent average in other mature economies.
“There’s an urgent need for institutions to change their allocations and not to be a sleeping shareholder,” the government official said.
This year’s rally in stocks has helped to carry Mr Abe to the brink of victory in Japan’s upper-house elections next month, thus cementing his hold on power for the next three years. Despite a recent dip, the Topix remains one of the best-performing benchmarks in the world, up 44 per cent over the past six months, buoyed by steady inflows from foreign investors and a revival of trading activity among domestic retail investors.
However, while many investors are convinced that Mr Abe’s determination to revive Japan through stimulus and structural reform will keep pushing the market higher, others are less sure.
A public commitment to support stocks from the GPIF “would be a reason for overseas investors to step up their buying, since we are consistently asked why Japanese investors, and pension funds in particular, have not been doing so”, said Masatoshi Kikuchi, pan-Asian equity strategist at Mizuho Securities in Tokyo.
The GPIF was established in April 2001 to manage funds in Japan’s public pension system. Its current base portfolio, set in 2006, is allocated 67 per cent to Japanese bonds – with a tolerance of 8 per cent either side, due to market moves – 11 per cent to Japanese stocks, 9 per cent to foreign stocks, 8 per cent to foreign bonds and 5 per cent to short-term assets.
Raising the assumption for long-term inflation from 1 per cent to 2 per cent – in line with Mr Abe’s policy – would lift the GPIF’s target return to 4.2 per cent.
Achieving that target return could require lifting the weighting of domestic stocks in the portfolio to a baseline of 17 per cent, according to calculations by Naoki Kamiyama, chief strategist at Bank of America Merrill Lynch in Tokyo.
The government plans to reshape investment strategies for the roughly Y200tn in assets held by 190 public pension funds, aiming to complete the shifts by the end of the fiscal year ending in March 2016.
Mr Abe’s growth programme, dubbed “Abenomics”, depends on investors across Japan rebalancing bond-heavy portfolios towards riskier assets, while allowing the central bank to mop up the debt they offload.
Now we read the government of Japan is reviewing the investment strategies of Japan's giant pension funds, urging them to invest more in domestic equities and infrastructure. Some commentators think this is a sensible shift, and while I'm the first to admit that Japan's pension funds need to diversify their asset allocation away from domestic bonds, it concerns me when any government meddles in public pension funds.
One of the central pillars of proper pension governance is to separate government from the investment decisions of public pension funds.As an example of proper governance, look at how the Canada Pension Plan Investment Board addresses its management and governance. All other large Canadian public pension funds follow a similar governance model to that of CPPIB.
But governance issues aside, the other problem is that by telegraphing such a move, Japan's equity markets will once again be vulnerable to the 'animal spirits' that inflated Japan's bubble economy in the late 80s. This reflation policy is what the government wants but it's going to be a free-for-all for hedge funds and speculators who will drive asset prices up to insane levels. But when the music stops, the Japanese economy risks falling back into a deeper deflationary contraction than the one it experienced after the previous bubble.
My advice to the government of Japan is to review the governance models at Canadian, Dutch, Danish, Swedish and Norwegian public pension funds and think carefully before implementing any changes to their asset allocation. Japan's giant pension funds move very slowly, are hampered by bureaucracy and government intervention, and need to revamp their governance to improve their long-term performance and meet their target returns.
Importantly, proper governance will lead to better and more timely asset allocation decisions across public and private markets. It will better align the interests of pension fund managers to those of stakeholders and ensure that risks being taken are not exposing funds to devastating losses down the road.
And as I stated recently, most U.S. public pension funds also need to revamp their govermance and compensation to attract and retain qualified managers who invest in public and private assets. The lack of meaningful reforms in the governance of U.S.public pension funds is truly disconcerting, especially since the financial crisis exposed their governance deficiencies. Sadly, the only reforms going on focus on shutting down defined-benefit plans, which will leave millions more vulnerable and anxious about retirement.
But the seismic shift in Japan which began last November is important and now that the government is targeting Japan's giant pension funds, it's sending a signal that it intends to combat the deflation dragon using any means necessary. Changes to the investment strategies of Japan's public pension funds will have huge implications for global asset allocators, all chasing yield in a low growth, record low interest rate environment.
Below, Ian Bremmer, president of Eurasia Group, talks about economic challenges facing Japanese Prime Minister Shinzo Abe and the performance of U.S. President Barack Obama. Bremmer speaks with Trish Regan and Adam Johnson on Bloomberg Television's "Street Smart." Sean Darby, chief global equity strategist at Jefferies Group Inc., and Alessio de Longis, a portfolio manager at OppenheimerFunds, also speak.
And Jim McDonald, chief investment strategist at Northern Trust Corp. in Chicago, talks about U.S. and Japan's financial markets. McDonald also discusses the prospects for Federal Reserve monetary policy and China's economy. He speaks from Seoul with Susan Li on Bloomberg Television's "First Up."