Different return targets mean Japanese pension funds are less likely to follow their Western peers as they venture out to overseas markets.

It would be wrong to imagine that Japanese pension funds will follow the global herd by upgrading their return demands, delegates at AsianInvestor’s Institutional Investment Forum Japan heard last month, but there will likely be a high level of learning and interaction in other aspects.

Katsuyuki Tokushima is head of pension research at NLI Research Institute. As an adviser as well as a board member for a number of Japanese pension funds, he noted how corporate pension funds, especially, have relatively modest return targets between 2% and 3%.

Any additional return above target is simply not appreciated, Tokushima explained.

Katsuyuki Tokushima

“Japanese pension funds’ preference is to suppress the downside risk,” he said. “If a return of 2% is the target, then 2% will also be regarded as sufficient. That is in line with the understanding of the pension funds’ members, which is important, so there is no need to copy the foreign pension funds’ portfolios from the risk-return perspective.”

Japanese investor appetite for overseas investments stems from a general need to diversify away from their massive domestic exposure. But it is reinforced by the low interest rates environment in Japan, which has reduced the appeal of domestic fixed-income products.

Low interest rates elsewhere are also making alternatives assets more appealing.

Due to the relatively high cost of hedging dollar investments back into yen, however, Japanese investors are likely to target overseas investments with foreign-currency return profiles of up to 5%. That will ensure that the final return target of around 2% to 3% can be achieved.

Tatsuo Ichikawa, who heads the quants team in the investment division at Japan Post Bank, said the bank habitually interacts with other institutional investors such as Canadian pension funds or Asian central bank to compare notes.

Tatsuo Ichikawa

“Are they actually quite advanced in terms of investment management [compared to Japanese institutional investors]? Well, they are not, but they are quite flexible and can actually take appropriate risks according to the change of the market – that is the difference,” Ichikawa said.

GOOD TO TALK

Ichikawa said he saw value in consulting with foreign pension funds on such areas as investment products, allocation models, artificial intelligence and machine learning as well as environmental, social and governance factors (ESG).

Governance, in particular, is very important for Japanese pension funds, which means stakeholders have to be on board as new overseas portfolio models are pursued and new investment opportunities are explored.

“But if you can explain that to your participants, for example, that you have to review or reshape portfolios on a regular basis or continue rebalancing, I think new models can become appropriate in Japan,” Tokushima said.

Right now, the focus in Japan is to stabilise portfolios and consolidate prior gains while still diversifying, Ichikawa added.

“We have to resort to overseas products for investment, but that entails foreign exchange risks. So how we ... control those currency risks ... is important,” Ichikawa said.