GPIF's CIO Warns of Synchronized Global Markets
Global markets have become so synchronized that money managers risk losing on every front, according to Hiromichi Mizuno, chief investment officer of the world’s largest pension fund.Hiromichi Mizuno has a very tough job, he's steering the world's largest pension ship and it's not headed in the right direction.
Japan’s $1.5 trillion Government Pension Investment Fund lost money in equities, fixed-income and currency positions in the last three months of 2018, Mizuno pointed out on Tuesday in Sacramento, California.
“Conventional wisdom of portfolio diversification is when we lose money in equity we make a profit in fixed income,” Mizuno told the board of the California Public Employees’ Retirement System, the largest U.S. pension. “But we lost in every single asset classes and lost in the currency translation as well. It never happened in the past.”
The Japan system’s annualized returns were 3.03% from fiscal 2001 to 2018, compared with a more than 6% annual average for Calpers, which has an annual target of 7%. More than half of GPIF’s portfolio was in domestic stocks and bonds as of March 31. Many Japanese bonds carry negative yields, while the country’s stocks have been falling since a high in January 2018.
The benchmark Topix index of shares tumbled 18% in the last quarter of 2018, and is up 0.2% this year.
GPIF is seeking uncorrelated returns by pushing into private investments, which can make up as much as 5% of its portfolio. Mizuno said it’s becoming an increasingly crowded trade. Alternative investments accounted for 0.35% of GPIF’s total assets as of the end of June, up from 0.26% at the end of March, according to its latest performance report.
“Everybody is trying to increase the private assets, or like a private investment, because obviously it’s not all correlated to the public market,” he said.
I can sum up GPIF's poor performance over the last few years in one sentence: "There's too much beta -- and not good beta -- dragging down the overall performance and introducing too much volatility in the Fund."
I recently wrote a comment on whether too much beta is dragging down Japan and Norway and while I concluded "yes", it's important to note some major differences too.
Norway's giant sovereign wealth fund has more international equity exposure whereas Japan's giant pension fund invests too much in local Japanese stocks and bonds, dragging down overall returns.
Interestingly, Reuters reports that Norway's central bank recently recommended the country's giant wealth fund shift more investments to North America:
Norway’s $1 trillion sovereign wealth fund should shift billions in investments from European stock markets and instead invest more in the United States and other North American markets to seek higher returns, the fund’s manager recommended on Tuesday.It only makes sense for Norway’s sovereign wealth fund to shift more assets to North America, especially the US market where you have roughly 22% of the S&P 500 made up of technology shares which have helped US markets outperform all other markets over the last ten years.
The world’s largest sovereign wealth fund has historically given higher weighting to European stocks, focusing on countries that Norway does the most trade with, and a lower weighting to those of North America.
But the Norwegian central bank, which manages the Government Pension Fund Global, said this was no longer necessary, and it wanted the fund’s portfolio to better reflect the available pool of investments.
“We can all see that both return and the common measure of risk has been better in North America in the past years than it has been in the rest of the world,” Egil Matsen, the deputy central bank governor in charge of the fund, told Reuters.
He declined to say how much of the value of the fund could potentially shift further to North American equities.
“We are not specific on that, and that is a conscious decision,” he said, stressing that it would be up to the finance ministry, and parliament, to decide whether to take up the central bank’s advice.
If they do, it would mean potentially billions of euros, pounds and other European currencies of investments would shift from Europe to the United States and other North American markets.
As it stands, Norway’s rainy day fund, which invests the proceeds of the country’s oil and gas production, owns more European stocks and fewer U.S. shares than the size of those markets would dictate
But the fund eased the policy of directing investment to Norway’s most important trading partners in 2012, the last time it reviewed its regional weighting.
The fund has since reduced its exposure to European shares from 50% of the total equity holdings to about 34% by the end of 2018. Some 43.0% of the fund’s investments were in North America at the end of last year and 17% in Asia.
There are other reasons to shift more assets to the US including the 'safe haven trade' which has dominated markets of late:
"In a world dominated by tepid economic growth, mediocre returns & a mountain of negative-yielding debt, foreign investors see American assets as a haven: They bought nearly $64 billion of U.S. stocks and bonds in June, the largest sum since August 2018" https://t.co/T6bY1BZ2H0 pic.twitter.com/sBvuJOaJmi— Trevor Noren (@trevornoren) August 29, 2019
What else? Norway's central bank stated the country's sovereign wealth fund should have greater autonomy to invest in unlisted equities, with up to one percent of the equity portfolio that could be dedicated to that type of investment:
“The Bank believes that a limit of 1 percent of the equity portfolio would be sufficient to address the intentions behind this type of investment,” the central bank said in a letter to the finance ministry published on its website on Wednesday.Go back to read my comment on how too much beta is dragging down Japan and Norway where I stated the following:
[...] both Mizuno and Slyngstad need to ramp up their allocations to private markets and to do this properly, they really need to think outside the box. Given their giant size, it won't be easy to scale up private markets, something they're both very aware of.More recently, GPIF revealed its new fee structure to get better alignment of interests from its external managers because while approximately 20% of the fund’s assets are actively managed by the asset managers, only a small number of funds achieved the target excess return rate from 2014 to 2016 (watch last clip below).
Why ramp up privates and why is the strategy so important? Because the volatility of these giant funds is quite frankly, unacceptable even if they invest over the long run, and they need to to reduce it by partnering up with the right partners, getting the most bang for their buck while reducing overall fees.
To be blunt, they are both late to the private markets game but if they have the right partners and strategy, that doesn't matter.
These are public fund managers where it's becoming increasingly more difficult to beat passive investing (indexing) strategies, although that bubble will eventually burst:
An investor who successfully bet against mortgage securities before the 2008 crisis sees another opportunity emerging from what he calls a "bubble" in passive investment. https://t.co/t5qqtHc0iQ— Lisa Abramowicz (@lisaabramowicz1) August 28, 2019
As far as private markets, GPIF's CIO Hiromichi Mizuno is right to note everyone is trying to increase their exposure to dampen volatility from public markets but as CPPIB's CEO Mark Machin recently warned again, a lot of mature pension plans are taking on more liquidity risk than they can afford, putting a third or more of of their assets into illiquid asset classes.
And if a major crisis hits them hard, they will be forced to sell their "liquid assets" at distressed prices or worse still, sell their private holdings too at distressed levels (giving more opportunities for CPPIB and other large investors to buy private market assets a lot cheaper).
Lastly, in my recent comment going over how the pension world is reeling from plunging yields, I mentioned Reuters reports that Japan's government unveiled estimates on Tuesday that showed public pension benefits steadily declining during coming decades, as it prepares to open up a debate on social security reforms needed to support an aging population:
Curbing bulging welfare spending is a vital step toward fixing the industrial world's heaviest debt burden, which is currently more than twice the size of Japan's $5 trillion economy.This is the backdrop that GPIF is contenting with and you should listen very carefully to Hiromichi Mizuno in the last clip below to understand the nature of the problem and what GPIF's mandate is over the next 100 years.
While Prime Minister Shinzo Abe's government has made welfare reform a top priority, it has moved slowly due to fears that it could alienate the public.
Japan has one of the oldest populations in the world, due to a low birth rate and people's longevity, putting pressure on its pension system.
In its pension estimates - which are issued every five years to gauge health of public pensions - the government estimated monthly pension benefits at 220,000 yen ($2,087.48) per model married couple, worth about 61.7% of pre-retirement income.
This pension-to-wage ratio is projected to fall to about 51-52% by the late 2040s, with the possibility of sliding further to around 45% in the 2050s, depending on growth and population outlook.
By some estimates, the ratio would fall below 40% in the 2050s, assuming the national pension fund dries up while the economy contracts mildly and labor participation stalls.
The government presented six types of estimates based on various scenarios, including a high economic growth case and base-line case.
The estimates also took account of optional scenarios such as a wider range of part-timers include in corporate pension schemes, and delayed pension payments for people who work well past their retirement age.
The estimates were largely unchanged from the prior projections made in 2014, due partly to rises in the number of people paying into the system and rising yields on investment.
The government has vowed to keep the average pension-to-wage ratio from falling below 50%, but worries are persisting Japan's 'pay-as-you-go' pension scheme may be unsustainable, with fewer workers paying into it and a larger retired population drawing from it.
"In Japan, adjustment in pension benefits and burdens has been lagging, while the overhaul of pension system has been left untouched," said Kazuhiko Nishizawa, social security expert at Japan Research Institute.
Pensions in Japan are a politically sensitive topic.
The estimates came a month after July's upper house polls, raising some speculation that the government may have delayed the release until the elections were out of the way.
In June, a report by advisers to the Financial Services Agency said a model case couple would need 20 million yen on top of their pensions if they lived for 30 years after retiring, fuelling doubt about pension sustainability.
Below, Japan's $1.5 trillion Government Pension Investment Fund lost money in multiple positions in the last three months of 2018. Bloomberg's Sarah Ponczek reports on "Bloomberg Daybreak: Americas."
Earlier this year, Bloomberg's Divya Balji reported on how the world’s biggest pension fund posted a record loss after a global equity rout last quarter of 2018 pummeled Japanese and foreign stocks.
I'm quite certain that GPIF's first half performance was a lot better than the last quarter of last year given the rally in global bonds and stocks. Maybe not as good as Denmark's ATP which posted a record 27% gain in the first half of this year but much better than Q4 2018.
Still, Hiromichi Mizuno has a giant beta problem to contend with and he's right to point out that global markets have become a lot more synchronized as rates plunge to record lows, wreaking havoc on global pensions. I've been warning my readers to brace for a bumpy ride ahead.
On that last point, Janet Mui, global economist at Cazenove Capital, and Jordan Rochester, currency strategist at Nomura International, discuss bond markets, gold and the risk of a global recession. They speak on “Bloomberg Surveillance.” Interesting discussion on why to own negative-yielding bonds.
Fourth, watch a panel discussion at this year's Milken Institute on filling the global infrastructure gap featuring Hiromichi Mizuno and other esteemed panelists. Excellent discussion, take the time to watch it.
Lastly and most importantly, GPIF's CIO Hiromichi Mizuno discussed GPIF with CalPERS's board at their August 20 Investment Committee Education Workshop. You can watch the clip below or here and CalPERS's CIO Ben Meng introduces him at the beginning. This is a must watch as Mizuno goes over a lot of details on GPIF that many investors need to understand.