Japanese pension funds are increasingly shifting their assets out of domestic equities and bonds in favour of emerging markets and alternative investments, according to a survey of 119 corporate pension funds conducted by JP Morgan Asset Management.
In fact, the survey finds an increasing number of pension fund CIOs are introducing ‘emerging market equities’ and ‘global equities’ as new asset-class categories, diversifying from the traditional, but simplistic, divide of ‘foreign’ versus ‘domestic’.
The survey finds 14% of pension funds already make this distinction and a further 19% say they intend to do so this fiscal year. Right now 53% include emerging markets in their global equity portfolios, but don’t make a formal distinction.
This shift, which reflects a trend started in 2009, is a sign that pension funds in Japan need to improve risk-adjusted returns even as return expectations have moderated.
“Japanese pension funds are now focusing more on risk control,” says Hidenori Suzuki, head of the asset manager’s strategic investment advisory group. “At the top of their agenda is how they can reduce portfolio risks while still maintaining the same target return.”
This has come to mean controlling downside risk, Suzuki explains. “They are increasing asset allocation to alternative investments, as well as introducing new types of investment strategies and a higher currency hedge ratio.”
The 2008 financial crisis saw many funds repatriate investments and increase home bias. This trend is reversing. For example, two years ago the average pension fund had 34.4% of assets in domestic bonds and 20.1% in domestic equities; those proportions have now declined to 30.5% and 18.0%, respectively.
The bond ‘bucket’ is being reallocated to alternative investments and domestic equities are being shifted to international stocks.
Although some asset classes find Japanese pension funds divided on whether they are increasing or decreasing allocations, there are a few clear trends. For example, 15% of funds say they will add to currency-hedged foreign bonds while hardly any will pull back from these; this compares to unhedged foreign bonds, which sees some funds either adding or subtracting.
Even more profoundly, 35% of respondents plan to add to alternative investments, and very few say they will scale back. Another 31% plan to add to emerging-market debt and zero report reducing this type of exposure.
Perhaps the most interesting plan in asset allocation is in equities. Hardly any funds say they will add to domestic equities while a third report plans to reduce this exposure. The picture for ‘foreign’ equities in general is quite mixed, with 22% saying they will actually cut these holdings while only 14% intend to add to them. However, look at ‘emerging market equities’ and there is a huge 53% who say they will add to this asset class.
Japanese funds are not strangers to emerging-market securities. More than 50% already have EM equity exposure and 20% have some EM debt. Similarly, these funds are very familiar with alternative investments, with over 80% reporting existing exposure to private equity, Reits and real-estate products. However, only 10% report having invested in infrastructure and commodity products.
The survey also finds quite a bit of turnover of managers in absolute-return strategies (mainly hedge funds). In fiscal year 2009 (beginning March 2009), 19% of funds sacked a manager while 14% added managers. In FY2010, only 13% sacked hedge funds while 18% added new managers. This shows higher turnover than in other alternative strategies.
The survey finds this turnover has led to the shedding of equity market-neutral providers but an increase in demand for equity long/short, managed futures and macro strategies. Funds of hedge funds, which have been out of favour for two years, are just beginning to see new mandates.
JP Morgan’s survey also finds the March 11 earthquake/tsunami is not affecting investment plans or outlooks for the vast majority of pension funds, with 89% reporting their policy remains unchanged.