Japan unshackles its public pension funds

A government taskforce has called for GPIF and other public funds to fundamentally restructure to seek higher returns, diversify and revamp governance.
Japan unshackles its public pension funds

Japan is on course to completely overhaul the goals, management and governance of its public pension funds, with a view to making their stewardship of more than ¥200 trillion ($2 trillion) of assets more active, more diversified and more focused on generating higher returns.

A panel established in December, shortly after Shinzo Abe took power as prime minister, yesterday (November 20) published its final report, sending its recommendations back to his cabinet. It is now up to Abe and his ministers to decide which recommendations to back and how to implement them.

The ‘Panel for Sophisticating the Management of Public/Quasi-public Funds’ was charged with figuring out how to make public fund investing match Abe’s goal of economic revival.

The panel’s meetings, which began in July, focus on the ¥120.5 trillion Government Pension Investment Fund (GPIF), the ¥17.5 trillion Pension Fund Association for Local Government Officials (Chikyoren), the ¥7.8 trillion Federation of National Public Service Personnel Mutual Aid Association (KKR) and the ¥3.6 trillion Promotion and Mutual Aid Association for Private Schools (Shigaku Kyosai) – among others.

Firstly, the panel calls for investment objectives to focus on beating the inflation expected to result from ‘Abenomics’. This means revising asset allocations that are too exposed to domestic bonds, in order to improve returns and mitigate the risks of rising interest rates.

In addition, the panel suggests public funds seek long-term investment exposures and generally higher returns. That means carving out bigger portions of risk-seeking portfolios. Whereas in the past surpluses were automatically placed into ‘safe’, low-risk investments, now they should in some cases “adopt a middle-risk, middle-return approach”, according to the panel’s final report published yesterday.

The panel also suggests public funds be given flexibility in how they pay commissions and fees, noting that these have been driven down, but at the cost of good advice or access to the best products.

To realise these goals, public funds should diversify into new types of assets, including real estate investment trusts, infrastructure, venture capital funds, private equity and commodities.

The report does not mention hedge funds, but Sadayuki Horie, senior researcher at Nomura Research Institute and a member of the panel, says the GPIF and others will need to consider other long-only allocations to riskier parts of the fixed-income universe as well as equities.

While Japanese officials do not like to think of carve-outs of GPIF or other assets as creating ‘sovereign wealth funds’ (because GPIF is a pension fund, with a liability), the report says “…while investment diversification could lead these investors to be deemed as sovereign wealth funds, there would be no problem as long as they comply with the 2008 internationally agreed code of conduct known as the ‘Santiago Principles’.”

Other details in the report include a call to adopt fundamentally weighted benchmarks in addition to market-cap weighted indices, noting that Japan Exchange Group and Nikkei will soon introduce an index, the JPX-Nikkei 400, based on factors such as return on equity.

The final, perhaps most important suggestion by the panel is to change the governance structure, by shifting the investment committee reporting line. Currently it is part of the administrative arm of these funds, but the panel suggests it report directly to the board of directors, independent of the CEO. The board would continue to report to the minister in charge of the fund.

There is no way the GPIF, for example, could handle these changes today. It is run by a very small staff, less than 100 people, which works because almost all allocations are passive and simple. Therefore these funds will have to expand their headcount and hire more people with market experience – which could well prove a cultural shock to the current breed of bureaucrats.

Horie says that, over time, funds such as GPIF will in-source more of their assets, as they develop their own expertise. But these funds will also need to outsource more mandates as they expand into new asset classes and adopt a more active-management stance.

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