As the largest institutional investor in the land, the GPIF (Government Pension Investment Fund) has its every move closely watched by the investment industry and the general public alike. The recent announcement that it will start to officially investigate possibilities for allocating funds to private equity and infrastructure was therefore met with a good deal of interest. Not least because of the clues the announcement contains about what appears to be a struggle for influence over its future course between the Ministry of Health, Labor and Welfare (MHLW) and the Ministry of Internal Affairs and Communications (MIAC).
With 120 trillion yen ($1.4trn) under its supervision, ultimately intended for pension benefits to Japan’s rapidly aging population, GPIF stands in the spotlight whenever the sustainability of Japan’s old-age provisions is the topic of discussion. Its asset allocation, which drives its long-term return potential, but also its short term risk-profile, is a recurring topic of debate. Thus far, the entity has stuck to a conservative allocation of 67% in domestic bonds and refrained from investing in all but the most traditional of assets. Only listed equities are deemed an appropriate asset class outside its core bond portfolio; nothing exotic like hedge-funds, real estate or other assets lacking liquidity.
The MIAC is responsible for evaluating the performance of administrative institutions such as GPIF. However, the Minister, Mr. Haraguchi, is arguing for a more balanced investment approach, with a larger role for investments generating higher returns over the long-term horizon that is relevant to GPIF. Mr. Nagatsuma is in charge of the MHLW and is the formal supervisor of GPIF. He, conversely, supports a “safety-first” approach and has thus far resisted any changes in the conservative investment strategy followed ever since the GPIF’s establishment as “Nenpuku” in 1961.
The adherence to a relatively unsophisticated investment strategy does not mean GPIF is lacking awareness of, or knowledge about, the more diversified investment approaches followed by other large pension funds such as CalPERS and APG. In fact, information exchanges, sometimes via specific research assignments to GPIF-related or private sector research bureaus, have been on the increase. The very unique circumstances of GPIF, however, in terms of size (GPIF is about 5 times larger than the second and third largest pensions funds in the world), organisational resources and governance structures, mean that so far this expertise gained has not been put into practice.
Perhaps developments in financial markets have played a role in bringing GPIF to step up at least its research effort into non-listed equity and infrastructure, as possible alternative investment categories. 10-year JGB yields have once again dropped below the 1% level, leaving GPIF with only very limited long term expected returns (and some significant risks in the shorter term if these yields would rise and cause mark-to-market losses) on the bulk of its portfolio. The Nikkei 225 dived below 9,000 during August leaving the domestic equity portion of the portfolio in the red and with the USD at levels not seen since the mid-90s, any foreign investments will not have made any money for a JPY-based investor from a currency perspective. With every 1% in extra return equating 20% higher pension benefits at retirement, or 20% lower costs during the contribution period, the impact of a more efficient portfolio are staggering.
Meanwhile a noteworthy detail of the announcement is that for infrastructure, non-Japanese assets are singled out for further investigation, while domestic infrastructure is apparently left aside as a no-go area. This is despite the reality that Japan’s basic infrastructure is aging and needs substantial investments over the coming decades. With national and local governments already burdened by an overhang of debt, GPIF’s long term capital in search for returns with stability would be a logical funding source. Were it not for a lack of an efficient mechanism to divert private funds towards domestic infrastructure projects. In Japan, these have traditionally been financed by public or semi-public means. A crucial role in financing infrastructure projects is played by the Fiscal Investment and Loan Program, a vast pool of money under the purview of the Ministry of Finance, amounting to more than Y200trn ($2.4trn) at the end of March 2010. Funds are disbursed via semi-public entities to a wide variety of causes requiring long-term finance. GPIF used to be a main source for FILP, but deregulation has led to this money being returned to GPIF for management on an arms-length basis.
The Ministry of Land, Infrastructure, Transport and Tourism (MLITT) has been active in trying to establish structures for public-private partnerships and private finance initiatives in the realm of roads and waterways. These developments only serve to highlight that a very long road lies ahead. The Ministry has set a target amount to be funded by private means of $15mn for next year. This is not something the GPIF will get too excited about. It thus seems that the MLITT will have a hard time making a dent in the monopoly of FILP for financing substantial projects in the infrastructure space. Mr. Haraguchi of MIAC has not only MHLW, but also the MoF to tackle on behalf of Japan’s pensioners and soon-to-be pensioners. That might just be one Ministry too many.
Oscar Volder CFA, is General Manager, Business Development at BNP Paribas Investment Partners in Japan