The Pension Fund Association (PFA), Japan’s largest private-sector retirement fund with $100 billion under management, wants higher returns but lacks sufficiently high-yielding opportunities at home, says chief investment officer Daisuke Hamaguchi.
Across the board, Japanese institutional investors are struggling with historically low returns on assets, such as domestic government bonds, in which they are heavily overweight, after the Bank of Japan launched its negative interest rate policy last in January last year.
Previously they had been content with low-single-digit yields, but they are finally being forced to take more action, especially since the country’s inflation rate is finally showing signs of life.
Japan is thus becoming a huge exporter of capital as asset owners seek to diversify their holding and higher return on investments overseas.
However, as they venture abroad in increasing numbers, the costs of hedging against foreign exchange fluctuations and rising US interest rates are swelling.
The local regulator, the Financial Services Agency (FSA), is so concerned about regional banks’ unrealised losses on dollar-denominated assets that it is investigating their foreign currency and interest rate exposures, according to people familiar with the matter. Regulators and the government want to see a rise in asset-and-liability management expertise across the board.
“Many Japanese investors are selling US bonds now to reduce their currency exposure,” said Shuichi Ohsaki, chief Japan rates strategist at Bank of America Merrill Lynch.
PFA is one of the few domestic pension funds that are already investing in alternative investments, such as hedge funds, property and private equity, though admittedly in a relatively constrained manner. The institution started investing in private equity back in 2003 and the vast bulk of those allocations are overseas.
PFA had a total of ¥11.8 trillion ($104.66 billion) under management as of March 31 last year, of which it runs about ¥5 trillion internally. It provides benefits to people who have left other corporate pension funds. Given its heft and position, it has influence within Japan’s asset management community.
PFA's APPROACH TO ALTERNATIVES
In an interview with AsianInvestor, Daisuke Hamaguchi, PFA’s chief investment officer, laid out the firm’s alternatives strategy.
Q What percentage of your portfolio is invested in alternatives?
A Of our roughly $100 billion of assets, the percentage we allocate to alternatives is not big. We have around 4% in hedge funds, 3% in private equity and 2-3% for infrastructure and real estate. We are not like some of the Canadian [pension] funds, which invest around 20% in infrastructure.
One of the issues is that we don’t have a lot of opportunity domestically for alternative investment.
Q What percentage of your assets in alternatives are overseas?
A Almost 100% is invested overseas. There is some onshore, but the market is still small as Japan does not have a large number of good funds. So obviously we have to bear some cost for monitoring overseas investments
Q Do you employ gatekeepers?
A We have four gatekeepers for our hedge fund portfolio and one big one for private equity, Hamilton Lane.
In the infrastructure space, we are working with Omers [the Ontario Municipal Employees Retirement System] on co-investing opportunities.
[PFA is involved with the Global Strategic Investment Alliance, an unlisted infrastructure vehicle set up by Omers and some Japanese pension funds in 2012, and the first of its kind in Japan.]
Q Will your allocation to alternatives stay the same in the foreseeable future?
A I think so. Again, we really need to have more domestic opportunities, then we could increase. But every time we have to go overseas and face currency risk, so we have to hedge, and hedging costs are rising because the Fed [US Federal Reserve] is hiking interest rates.
The basis swap market is very expensive. [On November 29 the three-month yen-dollar basis swap hit a record low of -94 basis points, while swaptions on 10-year dollar interest rate swaps rose to 90bp.]
Q How do you see the prospects for the Japanese private equity market?
A It is getting better. There have been funds in Japan for 20 years and they are still small. [In 2016 there was $10 billion worth of private equity deals versus $49 billion in China and $15 billion in India, according to Bain & Co’s Asia private equity report released this month.]
Our PE allocation is 3% but less than 10% of that is allocated domestically; the rest is mostly in the US and Europe. Asia [ex-Japan] is a small percentage.