Robust pension fund performance in Japan
The Nikkei average has spurted beyond its pre-Lehman levels, reaffirming the robustness of the market environment. Many pension funds remain wary after the difficult investment climate of the past few years, but a growing number are throwing caution aside and returning to a more risk-taking stance.
Pension funds are responding increasingly to currency volatility. Hideo Kondo, asset management director at DIC Pension Fund, says the rebalancing efforts are extending to forex. DIC’s basic allocation to foreign-currency assets is 25%. It is nominally a bit higher, but the fund works to keep the rate within a 25±5% range by using FX overlays and such as needed. With the abrupt weakening in the yen from last November, its FX exposure had ballooned to 33% by mid-December. It took the next month and a half to bring this back to neutral levels.
In FY12, when fiscal problems come to the fore in the US and Europe, investors tend to buy the yen as a safe asset. The currency strengthened particularly against the euro in the fiscal year’s first-half. Yen interest rates, though low in nominal terms, are relatively high in real terms due to deflation, increasing the currency’s attraction. From the standpoint of foreign buyers, the situation allowed for positive FX returns by accumulating yen. But the yen market, which had reached the ¥100/euro and ¥79/dollar levels on 13 November, suddenly took a sharp turn downward the next day. That was the day on which then-Prime Minister Yoshihiko Noda declared after a meeting with LDP President Shinzo Abe that he would dissolve the Lower House on 16 November and call a general election. That announcement sparked an immediate and ongoing correction in Japan’s overvalued currency. As of 8 March, the yen stood at the ¥124/euro and ¥95/dollar levels, i.e., it had slumped ¥24/euro and ¥16/dollar over the period.
According to Hideo Kawashima, director of the National Central Markets Vegetable and Fruit Wholesalers’ Association Pension Fund, the increased ratio of domestic stocks at some pension funds has been absorbed by the rise in foreign-currency asset prices, so rebalancing standards have not been breached.
Funds remain wedded to long-term stance: Is all-weather portfolio possible? Kondo notes: “Risk-on, risk-off – I’m not looking at such things at all in structuring and managing my portfolio. What I focus on is the economic scenario for 10 years hence.”
While short-term portfolio adjustments have been highlighted recently in the pension world, Kondo states: “Pension fund management should absolutely be conducted from a medium- to long-term perspective.”
DIC Pension Fund delivered returns of 2.5% in FY10, a year when most pension funds suffered a negative performance, and followed with a solid 3.02% in FY11 and 11% in FY12 (as of end-February). Kondo is less proud of his high returns than the mild degree of (brief) negative returns during the year. The positive performance is generally attributed largely to bonds in FY11 and stocks and FX in FY12. Kondo says that he aimed in both years for a so-called all-weather portfolio structure.
In FY12, 40% of returns through the end of February came from bonds. In addition to hedged foreign bonds and investment-grade corporate bonds, contributions came from hedge funds (e.g. credit market neutral strategies) adopted as alternative investments. Stock profits were boosted not only by listed shares but by overseas private equities acquired in the past. Kondo observes: “This is harvest time for private equities.”
Cumulative returns at the fund since Kondo took over as asset management director in FY03 peaked in July 2007 and had since trended downward, but suddenly hit a new high in January 2013.
FY12 proved a dramatic year for the pension world, which was rocked by the unprecedented scandal at AIJ Investment Advisors. Pension losses were first discovered at AIJ towards the end of the preceding fiscal year in February 2012, and subsequent examination raised deep suspicions of fraud. Many EPF that were managing funds on behalf of the government (“daiko”) emerged as victims. This triggered heavy pressure on the EPF system itself, where cases of struggling funds were on the rise, and the government, then ruled by the Democratic Party of Japan, sought the outright abolishment of a public-private system.
This thinking has not changed greatly with the advent of the LDP administration led by Prime Minister Shinzo Abe. The government has indicated it might allow healthy funds to continue, but the most likely plan would require an increase of over 50% in minimum liability reserves. This would be far too high for comprehensive schemes, which make up the bulk of EPF. While the elimination the system has not been finalised, the general direction of policy could drive EPF into disbandment. In fact, several EPF that had been considering restructuring plans such as benefit cuts in an effort to survive have begun to talk of disbanding.
This turnaround is gradually having an effect on their asset management. Pension funds fundamentally invest for the long term, but EPF that are thinking of breaking up have begun to look beyond their own demise (returning daiko to the government) and think not only of asset performance but of asset liquidity (convertibility). They are considering an exit from asset management in line with the system’s termination.