Japanese pension funds are reducing their weighting to equities, including domestic stocks, in favour of alternative investments, higher-returning fixed-income investments and Asia exposures.

Equities have served as the driver of returns for most funds, but this is not sufficient, says Akihiko Ohwa, manager of IBM Japan’s pension fund, speaking at a recent investment conference organised by AsianInvestor in Tokyo.

Ohwa told the audience that hedge funds and private equity can also serve as return drivers in pension portfolios, and that multi-asset funds may also help to manage risk.

Shunichi Kubo, director of investment at Nihon Keizai Shumbun Pension Fund, says the fund is decreasing its equities weighting to reduce volatility in the portfolio. Although most of the reallocation will go to Japanese and other G7 sovereign bonds, he recognises the argument that these are subject to interest-rate risk. Portfolios need to diversify in order to mitigate risk, not necessarily to earn a return, which could mean a relatively higher weighting to international equities, instead of Japanese stocks.

The Asahi Kasei Pension Fund is also cutting back its equity exposure, says its investment officer, Hiraku Matsumoto. He says JGBs’ risk/return profile is not a suitable substitute for stocks, so the fund is looking to ‘middle’ risk/return categories including alternative investments, to be augmented out of both equity and fixed-income buckets.

Matsumoto says alternatives are more accepted now but it would be a good idea simply to call them “other”, instead of “alternative”.

He also says there is a growing industry consensus that, within equities, Asia and emerging markets hold greater promise.

One fund that has a relatively large exposure to alternatives is DIC Pension Fund, whose asset-management director, Hideo Kondo, says it has been investing in private equity since 2004. Today 15% of the fund’s assets are in PE, including real estate and infrastructure, both in developed and emerging markets. He notes the fund would like to request its trustees to allow it to increase this allocation.

The comments made at AsianInvestor’s event correlate to a new survey of Japanese pension funds released by JP Morgan Asset Management. It shows many funds are decreasing their allocation to developed-country equities, especially domestic stocks. They are adding to alternatives, as well as to higher-yielding fixed income to Asian market exposures.

This reflects a concern about the high level of equity volatility, particularly in the domestic market, and a desire to avoid being too exposed to G7 sovereign debt woes.

Within equities, more than half of Japanese pension funds already have emerging-market allocations. They are also increasing exposures to non-traditional strategies such as long/short, fundamental index, minimum variance and concentrated portfolios, says JP Morgan.

Meanwhile, hedge funds and other absolute-return strategies now figure in 70% of pension funds’ portfolios, while new allocations are appearing across private equity, real estate (both public and private), infrastructure and insurance-related strategies.