Japanese pension funds are rewriting their asset allocation strategies in response to shrinking returns from traditional assets such as domestic equities and bonds, according to a newly-published survey.

The 11th annual survey of the sector by JP Morgan Asset Management (JPMAM) found that today’s priority among Japanese pension funds is international diversification.

In the survey of 120 Japanese pension funds and three so-called mutual aid pension schemes, the asset manager found that alternative investments had become a mainstream asset class for return-constrained Japanese pension fund investors.

JPMAM highlighted as notable that the survey showed 41% of Japanese pension funds had already adopted some new or different form of portfolio management framework.

It said they were rethinking asset allocation to better reflect their investment objectives, enhance their investment efficiency, and improve their diversification.

The survey found that 20% of pension funds had abolished domestic bond and equity categories altogether in favour of consolidating into global bond and global equity categories.

JPMAM interpreted this shift as a reflection of the funds prioritising international diversification.

“Within these newly-condensed buckets, exposure to domestic assets is generally falling at the expense of greater allocation to foreign assets,” said JPMAM.

There was increasing adoption of asset allocation strategies modelled on a variety of role-based, risk-based or factor-based approaches, according to the manager.

“This gradual adoption of more dynamic and holistic approaches to asset allocation suggests Japanese pension funds are experimenting with portfolio construction in the search for superior diversification.”

It gave as an example that some pension funds had begun categorising assets based on their risk level within the portfolio, with a 60/40 split between ‘base assets’ generating steady income and ‘growth assets’ seeking higher returns.

“Others are redesigning asset allocation on role-based categories, such as assets intended to help meet liabilities, cover payments or provide long-term growth appreciation,” it said.

Yoichiro Nitta, JPMAM’s head of institutional sales, said: “As these institutional investors grow increasingly sophisticated, lines are starting to blur between individual traditional ‘asset classes’ as investors focus more on underlying return drivers.”

Japanese corporate defined benefit pension plans would continue to face a challenge to generate returns sufficient to fund their obligations, Nitta said.

“We expect to see institutional investors continue to push the envelope on alternative and non-conventional allocations and innovate with new asset allocation frameworks to try to bolster returns and increase portfolio resiliency,” he said.