Government Pension Investment Fund’s (GPIF) investment return might have fallen less in the last fiscal year had it deployed active strategies for its foreign equities. But this relative performance alone may not be enough to convince the pension fund to shift some of its mostly passively managed assets back into active management.

The pension fund recorded a painful -5.2% rate of return for its ¥150.63 trillion ($1.43 trillion) investment assets in its fiscal year of April 2019 and March 2020. Foreign equities were the biggest drag on its return, as the asset class fell by 13.08%.

The decline was most pronounced at a negative 21.88% during the pandemic-induced market meltdown in the first three months of 2020, GPIF's annual report released last week showed.

Source: GPIF

However, the asset class might have suffered much less had the pension fund had more of it managed under active strategies. The benchmark for foreign equities returned -13.4% during the year. The excess rate of return over the benchmark was +0.32%, with active investments registering +3.17% and those passively managed yielding +0.02%, the report said.

“In active investment, our return outperformed the benchmark in part because of the positive contributions of security selection in the automobile and automobile parts sector and the consumer services sector, in developed markets. In the emerging markets, security selection in the materials sector, as well as the medical products, biotechnology, and life science sector contributed positively, among other factors,” the report said.

But over 90% of GPIF’s foreign equity holdings were passively managed during the year, far higher than the 78.74% passive rate for its portfolio as a whole. As a result the pension fund was not able to reap the benefits of active management for the foreign equity asset class. 

When asked about whether GPIF would consider shifting some assets to active in light of this outcome, a spokeswoman declined to comment directly, only saying that “owing to its asset size, GPIF mainly deploys passive investing".

The world’s largest pension fund continues to mainly allocate its assets to external passive managers despite having introduced performance-based fees in April 2018 to incentivise active managers to perform better. Under this arrangement, GPIF offers active managers a low base fee. However, the manager gets an extra fee if he or she achieves a targeted alpha.

That said, Covid-19 has upended global markets. With its effect still being felt, there is no guarantee that every active manager will outperform an equity benchmark.

"Covid-19 was unprecedented in terms of its magnitude and its unique impact on the economy.  Although we know more about the nature of its impact in retrospect, it was especially challenging for active equity investors in the first quarter with plenty of unknowns," Shigeto Nagai, head of Japanese economics at Oxford Economics, told AsianInvestor.

In hindsight, even if the active fund managers whom GPIF hired were good, it does not necessarily mean that it should structurally increase the share of active investment because there is always a chance that the managers could make mistakes and underperforme too, Nagai explained.

More importantly, given the very long-term nature of GPIF’s mandate to fund pensions, discussion of “active versus passive” has to be made with reference to a much longer time horizon, he said.

PASSIVE BENEFITS

Another reason GPIF may well feel it appropriate to maintain its emphasis on passive strategies is the fact that in domestic equities they worked well.

Japan's local equity market also had a torrid time, with the benchmarks for the asset class showing a -9.5% performance. However, GPIF's returns were worse than this, mostly courtesy of active managers, which recorded a -2.08% return versus their already underwater benchmarks. In contrast, passive managers were only -0.01% down, reflecting their tiny fees.

“In active investment, the return underperformed the benchmark because of the negative contributions of security selection in the medical products sector, the electronic machinery sector, as well as the information and telecommunication sector and the service sector, and other factors. In passive investment, the return was comparable with the benchmark,” according to the report.

Regardless of the merits of passive or active strategies, foreign equities rebounded sharply in the first quarter of this fiscal year, returning 19.99% between April and June, the most among all asset classes. With a majority of its assets under passive management, GPIF would have reaped the benefits of that gain, although the fund declined to comment on whether it had shifted some assets to active management during those months.

In fact, while Covid-19-driven market distortions have prompted discussions that active asset management may have a competitive advantage during times of volatility over passive strategies, respondents to a survey by investment professionals association CFA Institute do not think it will stem inflows into passive management vehicles.

“While it might seem intuitive that active managers should outperform during periods of market dislocation or high volatility, breadth and dispersion of sectors and individual stocks are more important ingredients to active stock-picking skills turning into outperformance,” Kevin Anderson, head of investments for Asia Pacific State Street Global Advisors, said in July when asked whether institutional investors should increase their weighting of assets under active management strategies.