GPIF CIO laments passive manager stewardship plans

Hiromichi Mizuno of Government Pension Investment Fund explains why he is disappointed so far with passive manager proposals to engage more with the firms they invest into.
GPIF CIO laments passive manager stewardship plans

Government Pension Investment Fund's (GPIF) chief investment officer, Hiromichi Mizuno, granted AsianInvestor a far-ranging interview at our 7th annual Japan Institutional Investor Forum on March 15. 

In the first part of that interview below, Mizuno discusses why the organisation has begun engaging with environmental, social and governance (ESG) concepts when picking asset managers. He also explains his disappointment so far with the corporate governance and stewardship solutions offered by the passive fund managers that run the majority of GPIF's ¥162.27 trillion (1.55 trillion) in assets under management. 

Q Why did you join what you saw as sleepy institution and since then push it to heavily engage in ESG and stewardship?

I understood before I arrived that some called GPIF a sleeping lion. And I didn’t want to make it an awakened lion but at least an awakened dog. So we have been trying to do a lot of things to change the organisation and the system.

Compared to the people in this room I’m not an expert of particular asset classes, but I have some perspectives about the business model. When I look at the business model of GPIF and also this industry as a whole, I realised a lot of things should change for the benefit of our final beneficiaries, in our case the Japanese pensioners.

In short, I felt that there is some mission I could possibly achieve and some vision to change it. I didn’t mean to do this for very long, but I realised that [I needed to do so] until somebody else can pick this up.

Q How do you see your role as CIO at GPIF?

Before I joined GPIF I was serving on its investment advisory committee and I tried to analyse how the GPIF should operate as an organisation. The CIOs of other sizeable asset owner-peers are becoming more and more like the CIOs of asset managers and taking [the investment management of] more of their assets in-house. But GPIF is legally restricted from taking investments in-house, so it should create a different model and the CIO’s role should be different.

So I tried to create a new CIO model that affects the [capital market] system, including system sustainability. I understand that a lot of people regard me as a very unconventional CIO and it’s actually what I intended to become.

Q Why have you been such a strong proponent of using stewardship and ESG in your investments?

Another observation I made … was that asset managers have to either beat the market or their competitors to stay in the business. But most of GPIF’s money is managed passively; we will not be the beneficiary of zero sum competition within the industry.

So that’s why we thought we should make sure we are not going to be subject to systemic failure. It’s interesting to observe that as we [become] more globally diversified we become less vulnerable to each daily volatility or asset classes, but doing so has made us more vulnerable to system failure ... [If and] when the capital market system fails, we are dead.

So I have a very strong view that for the business of the capital markets to be sustainable, the society to support it must be sustainable. And for the society ... to be sustainable, the environment has to be sustainable. [These are] the fundamentals of system sustainability that we pay attention to. ESG struck me as a very convenient way to communicate what we are trying to achieve.

But asking an asset manager not to manage our money with short termism is not a very concrete way of communicating what we are trying to achieve, so we instead asked the managers to integrate or use ESG factors for their investment analysis, which were all long-term risk factors. That was the concept behind our advocacy for ESG.

One thing we have been very clear about is [that] now there is tremendous pressure on companies or businesses to improve their corporate governance ... we are demanding our asset managers engage with these companies to improve their corporate governance to reduce their future governance-related risk.

We had a very strong view two years ago that for the engagement between [an] asset manager and portfolio company to be effective, the corporate governance quality of the asset managers has to [act as] a role model. Unless the corporate governance of the asset manager is best in class, how can they expect their portfolio companies to improve their corporate governance? So we started asking the asset managers to improve their corporate governance and made this very clear in our ESG GPIF stewardship principles.

Q How receptive have they been?

When we started this campaign two years ago I would say the industry received it as a surprise that all of a sudden GPIF started talking ... very exclusively about the corporate governance of asset managers. But now every time the asset manager comes into my meeting they immediately start with how good their corporate governance is.

Just to give credit for the Japanese asset managers at least in terms of formality, the improvement in their corporate governance over the last two years [has been] quite tremendous. Now I have more concern about the global franchises [ensuring] their governance models are clearly established. Generally speaking we are getting positive traction.

Q What’s the end goal of this effort to raise corporate governance?

Over the last two years what we have done seems to be a lot of different initiatives we are trying to promote, but what we have done is very simple. We are trying to make the system more consistent, so when we expect the manager to engage with the company we engage with the asset manager.

Last year in our stewardship report we said we are changing the style of our engagement with our asset managers from monitoring to engaging. And that is the way to make it more consistent and we heard from asset managers that they are engaging with asset managers and sometimes voting against their executive pay schemes. But then we ask the same question and say ‘hey asset managers how do you remunerate your executives? [Are] there any bonuses?’

Another example is that we are trying to make it more simple and consistent [because] when GPIF is feeling concerned about the short-termism, that’s contagious. I’m always against the idea of asset owners having to report quarterly results, because when we sometimes feel the media bashing or stakeholder pressure on us I think we send the wrong message to the asset managers. I mean they sometimes use our feelings as their own excuse [for] how to approach the portfolio managers.

I feel a sense of responsibility that the GPIF or asset owners ... make sure we don’t concern ourselves about short-term results and are more conscious about the long-term performance of the portfolio.

Q It can be challenging to get passive managers involved in corporate governance and stewardship. How constructive have those conversations been?

That is probably the most controversial proposition we made two years ago with the stewardship activity report. We demanded all our passive managers ... become active owners.

It sounds a bit contradictory but given the GPIF cannot step up as an active owner, we have no choice but to ask our portfolio manager to do that. And given the passive managers [we employ] have the super majority of our voting power or our shareholder relationships, I have no choice but to ask our passive managers to step up.

We understood that, historically, passive managers were only evaluated for their tracking error and cost of management, and as all seemed to have very similar tracking errors whoever offered the lowest fees were evaluated best. But we asked them to change it because we have no choice but to. So if they wanted to manage GPIF’s assets as a passive manager they had to change.

It was very controversial and ... the immediate response from the industry was ‘we are not paid enough’. So one year later we made very clear in our stewardship’s report that we are willing to pay more if your new business model is compelling.

So now the customer demands the asset managers to do something new. I think what they should do is rather than complain that they are paid too little, they should come up with a business model proposition and discuss with us what would be a fair price for that service and we are still waiting for them.

Nobody’s come?

Some did but ... [their investment ideas haven't] been that compelling in my opinion, but we keep urging them. There was a very epic report that came out from [GPIF] and we made it clear that we are willing to increase our fee if your new business model proposal is compelling.

So I think we did our share of responsibility and we are waiting for our service providers to respond to that and hopefully they understand now that we are receiving less and less complaints about our fee level, but not many people are proposing us with a new business model.

If you think about this industry, all the resources and money and intelligence expertise is concentrated at the asset manager. The resources of all state pension fund managers are not comparable to the asset managers. So I always expect the asset managers to come up with a good idea and present [it to] us.

So of course we don’t expect passive managers to engage with 2,000 companies but [we want to see] how they [intend to] screen ... and what is their idea of most effectively fulfilling their stewardship responsibilities to respond to GPIF’s demand to be more active owners. Given our resources and lack of expertise we just have to be receptive and we are now waiting for the proposals.

At the end of the day we are like a consumer. We regard asset managers to be like Apple or Samsung; it’s their job to decide how to come up with their business proposition.

Look out for part two of the interview, in which Mizuno discusses why GPIF is introducing its performance fee structure for asset managers.

This interview has been edited for length.

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