Trimming risk

The predecessor of Japan’s Pension Fund Association (PFA) was set up in 1967as a federation of employees’ pension funds. In its current guise PFA came into being in 2005.

It provides benefits to people who seceded from employees' pension funds after a short period, usually less than 10 years. It undertakes aggregation of corporate pension plans, including defined benefit and defined contribution.

The association also conducts research on corporate pensions matters and offers support to help develop member companies, including the provision of counseling, advice and training.

The PFA has a total of ¥12.7 trillion ($106 billion), of which it manages about ¥5 trillion internally.

Q What is your funding ratio and what do you consider healthy?
A Right now it is about 108%. But it is complicated because 70% of the liability is calculated based on the relative performance of Japan’s Government Pension Investment Fund (GPIF) and PFA. We call it the Daiko portion. In other words, we manage some of the national pension system on behalf of the government. It is a somewhat leveraged position, meaning if there was a funding shock, 70% would be hedged. So 105-110% is more than enough for us. We have been trimming risk exposures (i.e. equities) for the last few years as the ratio went from negative to positive. We are gradually reducing risk.

Q When was PFA’s funding ratio negative?
A After the Lehman Brothers’ crash, so fiscal 2008 until 2012. At its lowest point the ratio stood at 85%.

Q How often do you calculate the funding level?
A Officially only once at the end of each fiscal year. But to tell you the truth, we roughly calculate it every day. We adjust our equity allocation depending on a change in the funding ratio.

Q How are you allocated now?
A Our equity portion stands at about 45%, of which 40% is domestic and 60% overseas. The remaining 55% is broadly in what we call fixed income, which includes hedge fund strategies, real estate and infrastructure, although long-short is included in equity.

Q So you don’t use the term alternatives?
A We do call it alternative, but for actual asset allocation decisions we use equity or fixed income. Prior to the Lehman shock we had a peak of 55% in equity.  We maintained that after Lehman, but now there has been a recovery we are trimming risk.

Q What was your funding level when you had 55% equity exposure?
A Our ratio allocation officially started right after Lehman. While it had been calculated previously, I tried to bring discussions on funded status into the investment arena. We formally introduced our dynamic asset allocation strategy right after the Lehman shock.

Q Did you use a consultant?
A Not formally. We developed a system ourselves that is straightforward, similar to the ones used by Mercer, Russell Investments and Towers Watson in the US and Europe.

Q So you have trimmed your equity allocation to 45%. How have you reallocated?
A Some went into hedge funds and infrastructure, but a lot went into domestic and foreign bonds.

Q What is your risk tolerance on the fixed income side?
A We have everything. We include high yield in the portfolio, with distressed positions through hedge fund managers.

Q When did PFA start making alternative investments?
A We started private equity in 2003. We use direct funds, not fund of funds, and we work with several gatekeepers in the US and Europe who recommend the funds. Then we do our own due diligence and decide. Private equity now makes up about 2% of our 45% equity allocation

Q Does that include co-investment?
A Yes, we do co-invest, particularly in Japan’s private equity market. But it is still relatively small.

Q Which risk exposures have you trimmed as your funding level increased?
A We have several trigger points, it depends on the movement of each market, particularly domestic versus foreign. As I said, we have 40% exposure to domestic equity and 60% to foreign equity. We maintain that through normal rebalancing.

Q What internal staff levels does PFA have?
A We have 30 professional investors, so we are relatively small. When I joined 10 years ago I started to hire experienced external fund managers. Before that PFA didn’t have many. I gradually included professionals in alternatives, but also in equities and bonds.

Q Do you have hiring needs now?
A Not immediately. Naturally we have turnover. We are a small organisation and not everyone can reach CIO level. There are good career opportunities outside PFA, that is evolution of the industry.

Q Have the private equity opportunities delivered what you expected?
A More or less. My predecessor started to invest and I only joined in 2005. But I have built this out incrementally. It has reached the level we targeted. We are in the last stage of the J curve. Despite that, the number is ok. We are at about target 3% above listed equities. We are trying to maintain that over the long term. The benchmark is MSCI World.

Q How do you view Asia and emerging markets?
A Emerging equity is about 10% of our overall equity portfolio, so we are more or less in line with the index. We started investing in emerging equity more than 10 years ago. Within that we do not have a specific focus on Asia. We do not overweight or underweight Asia against the benchmark. We let active fund managers construct the portfolio. The same is true on the fixed income side. We invest in emerging market debt in-house, more or less following a tailor-made index based on the GDP of emerging countries.

Q Do you have a strategy for China?
A Our exposure to China is small, 10% of emerging equity. Given that emerging equity is itself 10%, China represents 1% of our total equity portfolio.

Q Do you have interest in getting a QFII licence?
A No, I don’t think so. For foreign equity we use external managers.

Q What is your view on Japan’s corporate governance code?
A We initiated these discussions 10 or more years ago. Now it is a big national movement. In a sense we have a conflict since we are a corporate pension entity, our board of directors is representative of large Japanese corporations. So in some sense it is difficult to debate all the issues. It should be a lot easier on the part of pure public funds such as GPIF. In a sense we have transferred that [advocacy] role to them. We are not running in front anymore, but running together and we are comfortable with that.

Q Is there a risk the focus becomes more on manipulating ROE?
A I have a similar apprehension, that the governance discussion is still on the surface. ROE is one example. As asset owners we are encouraged to put more emphasis on ROE, but good investment practice is not to focus on the past or present, but to identify companies that will obtain higher ROE in the future. Past or present numbers should be discounted. Further, I am not comfortable with the discussion about independent directors. The number of outside directors is what is being discussed, rather than their substance. The discussion has shifted to superficial issues. Lack of merger and acquisition activity or the wide use of poison pills and cross-shareholdings is a more important issue. Those have been negating the efficiency and proper functioning of the market.