Corporate pension funds in Japan have posted their first positive performance in three years. They look to have emerged from the financial and economic crisis, with average yields of around 10% on average nationwide, making up to some extent for the shortfall of the preceding two years. For all that, there remains a decided lack of enthusiasm among corporate pension fund executives. The wounds from the Lehman shock do not appear to have fully healed.

After the three successive years of negative returns following the bursting of the IT bubble, most corporate pensions corrected their excessive reliance on domestic and foreign stocks in their portfolios. Beta diversification become the buzzword. However, this diversification strategy failed, at least in the short term, when the financial crisis hit. Fund managers, flummoxed as to how to move forward, have yet to regain their confidence despite the slight improvement in yields.

The biggest worry at present for pension funds concentrating on domestic bonds is a Greece-style shock that sends yields upwards worldwide. Governments have implemented colossal fiscal stimulus in the wake of the recent crisis, leaving huge deficits, and have issued a large volume of government bonds. Misgivings surfaced this year over Greek national bonds, and the fear is that such anxiety could spread to major economies with similar massive fiscal deficits and outstanding debt, including the UK, US and Japan.

One bond analyst has warned that government bonds are especially vulnerable in countries whose fiscal standing and trade balance are both poor; the UK and US are prime examples. If the problems extend to government bonds in core currencies, the consequences could be severe. The analyst feels that JGBs could be a safe haven, given the nation’s international trade surplus. But if a sell-off takes hold in government bonds worldwide, JGBs would follow as well, with a difference only perhaps in degree.

 Still, a falloff in government bonds (a rise in yields) would not be all bad for corporate pension funds. Pension liabilities (PBO) on retirement benefit accounts at large corporations use discount rates linked to government bond yields and thus change each year. A rise in yields is a challenge for asset management, but a higher discount rate also means lower pension liabilities.

The best scenario for corporate pension funds is a gradual uptrend in yields, but such a development now is questionable in the face of the nation’s large output gap and deflation. Interest rates have been trending downward worldwide for nearly 30 years since the second oil crisis. Japan has fallen into a deflationary state amidst the prolonged appreciation in the yen, the decline or stabilisation in oil and other commodity prices, the influx of cheap products from China, and the burst of the bubble economy. Short and long-term yields remain the lowest in the world.  Heizo Takenaka, former minister of economic and fiscal policy and financial services, said at a pension forum in January that we may be seeing the last of the high yen phase, suggesting that the yen could weaken over the medium term. If growth should continue in emerging economies, which account for over half the world’s population, commodity prices are likely to remain high. The aging of the Japanese population as the baby boomer generation reaches its 60s will spur a reduction in saving rates and a rise in yields. With an upward revaluation in the RMB in sight as well, the conditions supporting deflation and low yields in Japan are changing. Pressure from revisions in international accounting rules is also weakening. The initial idea was that losses from pension asset management should be recognised immediately as net losses on the earnings statement. Now, the prevailing view is that they should still be recognised immediately on the earnings statement, but as comprehensive losses and not included in net earnings.

 The Nikkei average slumped 51% in the 1990s. In the latest ten-year period, which encompasses the IT bubble collapse and the recent financial crisis, the index tumbled 44%. US stocks also turned in their worst performance ever. Moreover, it was a decade in which retirement benefit accounting was introduced at Japanese firms. Against this background, corporate pensions are said to be in an exceedingly severe environment. Whether this climate will improve is unknown, but it will probably not deteriorate further from the lows of the past 10-20 years. Just as bull markets are born on pessimism, Japanese corporate pension funds may very well enter a new phase from the present despair.

 Source: Nenkin Joho (R&I)