Views on improving the integrity of global capital markets
23 October 2012

Japan’s Government Pension Investment Fund, Among Others, Forced Away from Fixed Income

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With a debt-to-GDP ratio in excess of 200%, two lost decades and counting, and continuing economic suffering from the impact of last year’s earthquake and tsunami, Japan’s economic situation is not the envy of many people. Adding to this is the problem arising from underfunded pension funds, which is partly due to Japan’s demographics and a fund management approach with historically little diversification. Because of these challenges (or maybe thanks to them), large funds in Japan are being forced to rethink their portfolio management approach.

About 95% of Japanese government bonds (JGBs) are currently owned by domestic residents, as pointed out in a recent academic study analyzing the Japanese sovereign debt situation. State-owned institutions account for a substantial proportion of domestic ownership. Take the Government Pension Investment Fund (GPIF), for example, which holds close to 10% of outstanding JGBs. With assets under management of about US$1.3 trillion at the end of June 2012, it is by far the biggest pension fund globally. Almost 65% of its portfolio had been invested in Japanese domestic bonds at the end of June this year. Being one of the biggest investors in government bonds, it is no wonder that the Japanese government has been quite happy with it so far.

You can see the huge proportion of domestic assets GPIF is comprised of by adding the roughly 12% in domestic stocks this fund is holding to the domestic bond portion. With payouts of GPIF getting bigger than revenues, GPIF recently started to sell Japanese bonds. At the same time, GPIF sees the need for higher returns. Subsequently it has made efforts to diversify its portfolio, which is not surprising given that the annual yield of a 10-year Japanese government bond currently stands at 77 bps. As one way to diversify away from its bond-tilted portfolio, GPIF recently started its investment program into emerging markets and selected six asset managers to make its first investments in that region.

GPIF, however, is not the only mammoth fund in Japan from which a more diversified portfolio may be expected going forward. The Japan Post Group would be another example. Being 100% owned by the government, it consists of two huge institutions: Japan Post Insurance, which has about US$800 billion of JGBs among its security holdings, and Japan Post Bank, which owns about US$1.8 trillion worth of JGBs. According to Ryujiro Miki, investment risk manager at Japan Post Insurance Company, they hold roughly 30% of JGBs. Mr. Miki, who is a veteran investment professional, points out that the Japan Post Group will potentially be listed within the next few years as the Japanese government is looking to sell the stock of a number of holdings. A listing could have a great impact on the market as this raises the possibility that it diversifies its asset allocation away from domestic bonds.

A full-scale portfolio diversification may not be on the agenda in the short term, but it may happen in the mid to long term, according to some investment professionals. In a discussion with experts at Japanese asset management firms, it was noted that the traditional rather than risk averse approach taken by Japanese funds had actually served them quite well in terms of performance. Had Japanese funds invested more in foreign equity or foreign fixed income in recent years, their performance would have been considerably worse. Besides, Japanese funds have shown to be slow in reacting to changing investment environments. Given the fact that retail savers have continued to allocate much of their savings into bank deposits, which are then used for investment in JGBs by banks, demand for JGBs is not expected to dry up, at least in the short term. It was also noted that even a slight diversification away from JGBs to another asset class, such as domestic Japanese equity, may have a huge market impact given the size of assets under management at some funds. In this sense, GPIF, for example, must be very careful when considering diversification.

In Japan there are no formal pension fund governance issues involved with the allocation of Japanese government bonds to the investment portfolios of governmental institutions. According to industry experts in Japan, trustees are formally independent from the Japanese government. This is evidenced by the observation that trustees voice their opinions very freely in the respective investment committees, which would presumably not be the case were there an implicit agreement between governmental pension funds and the government to allocate JGBs regardless of investment policy needs. If there were any kind of measures associated with repression in Japan, it would be through extensive management of banks and other financial institutions, as noted in a recent BIS working paper on liquidation of government debt.

Given the challenges mentioned at the outset, there is certainly a possibility that holdings of Japanese pension funds will be more diversified going forward. Pension funds’ asset allocations may then reflect the interests of beneficiaries to a much greater extent than they do now. As a result, the present era, during which the Japanese government has been able to borrow with low interest, may be coming to an end in the not-so-distant future.

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About the Author(s)
Alexander Flatscher, CFA

Alexander Flatscher, CFA, is a former director of professional standards at CFA Institute. He was responsible for promoting the ethical standards, policies, and positions of CFA Institute in the Asia-Pacific region.

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