As the cost of retirement in Japan grows, so its companies are seeking to reduce their responsibilities. A key way has been to adapt the corporate pensions of their employees from defined benefit to defined contribution schemes, as this means they take less responsibliity for them.
However, this growing shift from DB to DC has ramifications for individual savers. Most important is the prospect their investment returns will fall.
DBs have diversified their investment strategies in recent years, especially into alternative assets, whereas DCs have a more restricted set of investment options.
“Japanese DBs are in general increasing their allocations to alternatives to find the risk-adjusted income return that fixed income can no longer deliver in this low interest environment,” said Kita.
“The investment profile of DCs is much more passive, with an emphasis on highly liquid mutual fund products and fixed income products such as deposit or life insurance products.”
That’s a problem, given that Japanese households currently have little interest in investing on their own, explained Katsuyuki Tokushima, chief pension advisor at NLI Research Institute’s Pension Research Center. He advises both public and corporate pension funds and is a member of several investment committees for pension funds in Japan.
“Japanese people might like speculation, such as exchange rates between yen and foreign currencies, but they don’t do actual investments. They typically have 50% of their assets placed passively in banks, insurances and pensions, and then homeownership in many cases take up a large share of the remaining half.”
The danger is that the generally risk-averse investments of households, when combined with low-returning, passive assets in DC schemes leave them with an investment profile that offers little downside risk, but low returns.
“People have been encouraged to be more assertive and invest a bigger share of their savings in equities because their fundamental diversification makes it sensible,” Tokushima said. “So far they don’t listen.”
This problem is not helped by the conservative nature of the DC funds.
DC plans are hobbled by accounting rules and restrictions. For example, they can only invest in Japan-domiciled funds, and it’s hard for them to invest in overseas alternatives investments except a few costly hedge funds, according to Konosuke Kita, Japan director of consulting at Russell Investments. These limitations have stymied the interest of asset managers and consultants in offering products.
That risks crimping the plans’ investment returns. Alternatives are increasingly a vital source of risk-adjusted return for DB funds in place of minimally yielding government bonds.
According to data from the Ministry of Health, Labour and Welfare, 65.1% of DB funds had made alternatives investments in 2017, with 48.3% allocating over 15% of their portfolio to the asset class.
In second quarter of 2019, JP Morgan Asset Management conducted a survey of 112 primarily DB Japanese corporate pension funds. It noted that participating DB funds allocated a record 21.3% of their portfolios on average to alternative investments such as property, infrastructure, private equity or private debt – up from 12.8% in its 2015 survey, and 5.4% in 2009.
Even with these allocations, most regular Japanese corporate pension funds have gradually decreased their target returns over the years, sources told AsianInvestor. According to the JP Morgan survey, the respondents’ average target return was 2.28%, versus 2.84% in its 2011 survey.
Because DC plans cannot invest in higher-yielding alternatives their returns are likely to be even lower. In the financial year ending March 31 2018, DB pensions returned an average of 4.45% while DC pension funds returned 3.1%, according to Japan’s Pension Fund Association.
Another reason why DC funds are not yet getting much attention is that their combined AUM remains quite small, although it is growing fast. DB funds had an AUM of ¥63 trillion ($578 billion) as of March 31 2019, whereas DC funds only had about ¥12.5 trillion, according to data from Trust Companies Association of Japan.
Kentaro Otani, executive director of institutional sales at JP Morgan Asset Management, believes a model will emerge where asset managers can pitch a variety of alternative investments to DC funds.
“Right now, there are technical obstacles for DCs to invest into overseas alternatives, as they need to invest in funds whose NAVs are calculated on a daily basis and face limitations,” he said. “I believe that a solution will be found to solve these obstacles.”
He sees one or more of three scenarios happening. The first would be that the investment rules in the Defined Contributions Act are loosened. The second is that DC funds take the initiative and push to create a way to invest into alternatives.
The third and most likely scenario is that asset managers begin creating solutions to get DC funds into overseas capital under the current circumstances.
With DC plans taking over in Japan, the government, the corporate pension funds and pension savers alike are slowly adapting to a changing retirement system. But the funds still need more investing options and their users need to be more assertive, if their pension savings are to accumulate quickly.
The country’s investment managers have a big role yet to play.
This story was adapted from a feature on Japan's pension system that originally appeared in AsianInvestor's Winter 2020 edition.