New dynamic at work
There is, by all accounts, a strong trend for a switch to more international and specialist mandates from plan sponsors among large corporations in Japan. The underlying problem is the size of the majority of Japanese pensions funds. Some 80% of the pension market would be made up of small schemes, with low tolerance of ‘risk’ investment and with home country bias still predominating.
There are 1,800 corporate pensions funds in Japan, in a market worth around Y60trn (e270bn), with maybe 100 pension funds managing in excess of ¥100bn, the average being at the ¥10-20bn level. Most of these would have a heavy bias towards Japanese assets and particularly domestic bonds. Noboro Yamaguchi, chief investment officer of the Japan Tourist Board Corp (JTB) pension fund says he guesses that only a limited number of funds have been re-balancing their portfolios to take account of the trend towards global diversification. “Maybe 150 of the 1,800 funds would have done so. People are not ready for the change. Many have no experience of investment and many of the pensions funds are not big enough to employ a trained person to manage and monitor the portfolios.”
Co-mingled funds would be a good solution for pooling these smaller funds, but the range of options currently offered by the Japanese trust banks is very limiting, says Yamaguchi. The cross–shareholdings between different organisations ensures that independence of asset allocation and fund management from the other investment disciplines is rarely achieved. For the future, the industry leaders are looking to emulate the master trust concept from the US, with segregation of roles between different specialisations, but centralisation of administrative functions. This will also enhance the move from balanced to specialised portfolios.
The foreign managers have made significant inroads already. According to Yamaguchi-san’s figures, the market share for non-Japanese advisory companies has grown from 8.6% to 30% in the last five years.
According to Rich Nuzum, director of William Mercer’s Tokyo office, the asset management market has become more competitive in the last two years, in that foreign players here have now become better staffed and resourced in the local market.
Indications are that at least half the range of managers Mercers now recommend within its global equity component, are operating in Japan, a doubling of numbers in two years. Nuzum comments: “Our view is that this is still one of the biggest potential asset management markets in the world and if a fund manager has product that is appropriate for this market, for example global equity/ world growth ex-Japan, and if they are thinking about where to build their business, then this is the best place to be.”
The trend towards sub-advisory relationships has accelerated. We have seen in the past couple of years tie ups such as Nippon Life and Putnam and Meiji and Dresdner Bank. Japanese asset managers are now looking for partners with no real presence here. One of the major Japanese asset management firms is sub-contracting to a foreign partner, to the extent that the foreign partners has direct control over an asset class worth around $5bn.
Asset allocation along international lines is still a major hurdle for the majority of pension funds, and a perceived lack of sophistication is hampering developments. Yamaguchi suggests that proper re-balancing wasn’t done in the year 2000 which resulted in returns for the year being 25-40% down after the share market collapses.
Another problem is that pension funds are using trust managers through balanced funds rather than specific mandates. The investment choice is set by the trust banks and Yamaguchi says, “we must get to the point where pension funds are more in control of their own asset allocation”.
Asset allocation for the JTB pension fund is 50/50 equity and bond, with 30% domestic equities, 20% international, and 40% global bonds inc-Japan (fully hedged) and 10% international bonds ex-Japan (unhedged). Yamaguchi says most of the other Japanese pension plans would be 35% Japanese bonds, 35% Japanese equities, 20% international equities and 10% international bonds. The JTB uses Frank Russell for asset allocation advice and reviews the strategy every three years.
The liability side has changed too. As of this year, Japan is adopting global accounting standard methodology. This represents a serious problem for pension sponsors, since unrealised losses from pension liabilities should be consolidated into their balance sheets. This puts them in a financially difficult situation, but may be another factor that forces them to address the need for higher yields by investing offshore.
The traditions will not crumble overnight, especially since many pension managers in Japan don’t have the sophistication required to make the correct decisions on such issues as benchmarking or credit analysis. Most of the large pension funds will use one of the international benefit consultants. According to Yamaguchi, most of the big ticket business goes to Frank Russell, with Watson Wyatt handling a large number of the small and medium sized accounts.
The Japanese asset consultants such as DIR, Nikko Research Centre and R&I, tend to have a more localised perspective which is still appropriate for many of the domestic plan sponsors. Yamaguchi accepts that the ways of the western consultants may not always be appropriate to apply to a Japanese pension fund, but “without their help, any change of thinking would not have been possible”.
The truth is that the work being done by the likes of DIR and Nikko is fairly sophisticated, including adopting Monte Carlo simulations of cash flow on pension funds and optimisation techniques for risk and return.
Hiroshi Miyai of the Nikko Research Centre says, “Our recommendations are based on quantitative historical returns using market equilibrium theory. We will recommend a range of core managers, and it is important to maintain the policy asset mix and core responsibility for 50-60% of the portfolio.”
DIR are also researching foreign asset managers, but take the attitude that foreign securities are difficult to recommend to many of their clients. Senior researcher Masashi Toshino says, “Foreign equities are attractive but we can’t perfectly hedge the currency risk , so investors remain wary of international exposure.” Nonetheless, DIR has a high estimation of the foreign houses, for their level of process, even for Japanese assets. For domestic equity funds, they list eight funds with a top ranking, half of which are foreign. For overseas assets, all of DIR’s top recommendations are foreign groups.
A new dynamic is provided by the turnover of existing, incumbent specialist mandates and, to a lesser extent, a broadening of asset classes.
Sponsors are cutting the number of regional specialist managers, limit the amount of monitoring they need to carry out. So there is more focus on global managers as a result.