Japan's lumbering public pension to be recast as agent of reform

[June 24, 2014]  By Chikafumi Hodo

TOKYO (Reuters) - Understaffed, underpaid and operating largely on autopilot since its inception more than a decade ago, Japan's main public pension fund - the world's largest - seems an unlikely choice to help shake up Japan's markets and reform its corporate culture.

But Prime Minister Shinzo Abe's package of growth measures due for unveiling on Tuesday will push for changes at the $1.26 trillion Government Pension Investment Fund (GPIF) that could shift hundreds of billions of dollars out of domestic government bonds into stocks, overseas assets and alternatives such as infrastructure.

Abe will also call for governance changes likely to make the fund more professional and independent, like its counterparts in Europe and North America, so it can take on more risk and prod Japanese companies for more investor-friendly policies.

"The core idea of GPIF reform is to change its bond-heavy portfolio in an environment where the country is moving out of deflation," said Kenji Shiomura, senior strategist at Daiwa Securities.

"But at the same time, the government also wants to improve governance at the country's corporations and boost efficiency through GPIF reform."

The reforms of the pension fund, which manages reserves of national and employee pension plans covering 67 million people, are targeted first and foremost at boosting its returns, by diversifying its investments and pursuing higher-risk, higher-return assets.
 

But by tilting the way the state-run goliath allocates its resources, they could have a huge impact on financial markets in Japan - and overseas.

The fund's current portfolio allocations call for putting the lion's share - 52 to 68 percent - of its money into Japanese government bonds. The figure was 53.4 percent at end-December.

That approach worked well enough during Japan's prolonged deflation, an ideal environment for earning stable returns from bonds, but is looking shaky as Abe's reflationary policies start to stir Japan's economy back to life.

With the fund under pressure to ensure it can provide for Japan's fast-growing ranks of retirees in one of the world's most rapidly ageing populations, Tuesday's growth plan is calling for quick action on a reallocation.

"I wouldn't be uncomfortable if the allocation to domestic bonds were lowered to somewhere between 30 and 50 percent," Yasuhiro Yonezawa, the head of GPIF's investment committee, told Reuters in a telephone interview last week. He gave no revised allocation for domestic stocks, now targeted at 12 percent.

If the bond allotment were put at the middle of his suggested range, it would free up about $170 billion - nearly equal to the market capitalization of Toyota Motor Corp <7203.T>, Japan's most valuable company - to put into domestic stocks, overseas stocks and bonds, or alternative assets such as real estate, infrastructure and private equity.

Investors have taken notice.

"When we traveled abroad to meet clients, they were extremely interested in GPIF," said Daiju Aoki, equity strategist at UBS Securities Japan. "They were keen to know how this might lift domestic share prices."

DAY JOBS

Located across from the finance ministry in Tokyo's government district, GPIF occupies the second floor of a non-descript building whose plain facade and smoky basement coffee shops are typical of the era that preceded Japan's 1980s financial bubble.

Its president earned just $168,000 in the year to March 2013, down 11 percent from a year earlier as the fund cut costs. Its 80 employees are a fraction of the 900 staff that vet fund managers and monitor performance at the Canada Pension Plan Investment board. And its investment committee is comprised of economists, academics and union and business representatives whose day jobs are elsewhere.

That is all set to start changing under planned reforms.

While the growth strategy only promised a broad commitment to improved governance, GPIF has already got approval to hire full-time investment committee members and investment professionals, and is selecting a consultant to review its salary and bonus schemes.

More significantly for the long term, the Health Ministry, which supervises the fund, could consider legislation to boost the fund's independence, along the lines of the central bank, which could give it free rein to pursue riskier strategies and a more activist stance towards the companies it invests in.

That could help it to achieve the sort of returns seen at Calpers, California's public employee pension agency, which has earned double-digit returns in all but two of the last 10 years. GPIF only managed that feat once in the past decade, and the 16 percent it earned last year still paled in comparison with the Japan stock benchmark's 50 percent surge.

These changes will not only bolster the fund's own returns, but would more firmly hold corporate Japan's feet to the fire to cater to the needs of investors with higher dividends and return on equity, and better governance.

The fund has invested small amounts in a new index, the JPX400, that focuses on metrics such as return on equity and operating profit, and adopted a Stewardship Code that requires shareholders to disclose votes at annual general meetings and engage actively with company management.

GPIF also surprised the asset management industry in April with its selection of new managers for its domestic equities portfolio aimed at increasing returns. Out of 14 newly appointed active managers for Japanese stocks, only four were Japanese, compared with eight in the previous line-up.

Of course, taking on more risk could leave the fund more exposed to a reversal in Japan's stock market. Such worries could make the authorities hesitant on implementing governance reforms.

"The ministry could get the blame if GPIF suffers a huge investment loss after a major overhaul in the fund's governance," said a Japanese expert in pension fund matters, who asked not to be named due to the political sensitivity of the issue.

"We are seeing many things coming out of GPIF, such as a new structure for fund managers in domestic equities, diversifying into alternative assets and a commitment to a quick review of its asset allocations, but we are not hearing much about governance so far from the health ministry."

($1 = 102.0500 Japanese Yen)

(Editing by Edmund Klamann and Alex Richardson)

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