Japanese corporate plan sponsors are having difficulty keeping up with the recent speed with which the Ministry of Finance has liberalised investment regulations. The largest plans along with foreign investment advisers have long been pushing for reforms to allow more effective asset management. In a sudden spurt concentrated mostly in 1997, the government has given corporate plans almost complete latitude to set investment policies and use outside managers of choice. However, most plan sponsors are not prepared to handle their new-found freedom.
Plan sponsors have gradually been permitted to be involved in investment decisions over the past decade, but the historical proscription against participating in asset management decisions still influences the attitudes of most sponsors. As a result, there is an enormous gap between the sophistication of the large plans and the rest.
There are two main forms of corporate plans, both of which are defined benefit in structure: employee benefit plans (EBPs) and tax-qualified plans (TQPs). At the end of 1997, there were 1,883 EBPs and 90,243 TQPs whose combined assets totalled $634bn ($1=¥100). However, only 200 EBPs and 25 TQPs currently have funded assets over $500m. The size of plans is one indication of their level of and need for a sophisticated investment policy.
At the end of 1997, over 97% of EBPs were qualified for in-house management, but only 54% had obtained approval and only 35% of those qualified had actually given mandates. Further evidence of the conservatism of EBP sponsors is shown in a recent Nikkei survey. With regard to their intended response to the abolition in December of the famous 5-3-3-2 asset guidelines, 59% said they will continue to entrust assets to managers within the previous restrictions, and 28% said they would review their portfolio's policy in light of these changes. As for plans to revise the asset mix for the new fiscal year beginning April, 53% responded that they had not decided anything, 25% expected to maintain their current portfolio structure, and only 16% expected to set asset allocation guidelines which exceeded the old rule.
As for intentions to give out specialist investment mandates, 70% of EBPs surveyed had no definite schedule for giving them, and 16% expected to hire specialist managers from April. A different survey conducted by the Pension Fund Association (an umbrella organisation for EBPs) found an equally strong streak of conservatism in sponsor attitudes: 84% of the 1,700 plans surveyed had no plans to hire specialist or semi-specialist managers, and 16% had.
The picture is quite similar for TQPs. Since April of last year, TQP sponsors are no longer restricted by the 5-3-3-2 rule, which required that at least 50% of assets must be invested in principal-guaranteed instruments including loans, no more than 30% can be invested in equities, no more than 30% in foreign securities, and no more than 20% in real estate. In a recent Nikkei survey of TQPs, 64% said they will continue to manage assets according to the old guidelines for the time being, and only 5% said they would follow the old rule at the plan level but make use of specialist managers.
Most plan sponsors do not yet set an asset allocation policy based on acomprehensive, Western-style asset liability modelling exercise. Instead, in response to the decline in returns available from the domestic market, they have recently tended to shift plan assets according to the level of absolute returns targeted by their external managers. As the guaranteed floor returns from life insurers has been ratcheting downward from 5.5% to 4.5% to its current 2.5%, a significant portion of pension assets has therefore shifted to trust banks and investment advisers. Also, foreign managers projecting higher returns from foreign markets have received greater allocations than many Japanese domestic managers.
Japanese sponsors have not yet developed an asset class approach to investment policy making and still tend to prefer leaving the diversification decisions to external managers. With regard to the use of specialist managers, investment advisers are normally given latitude to invest in a pre-agreed-upon basket of assets/ markets with the goal of producing a preferred level of returns, which has historically been the actuarially mandated rate of 5.5%. From last April, EBPs are no longer required to use this rate, but due to the current underfunding of most plans they continue to use a high return assumption for planning purposes.
Plan sponsors are moving away from their traditional asset allocation framework of trust banks and life insurer managers and are making greater use of new types of managers, particularly investment advisers. However, their investment policies are being set more because of projected levels of return than because of a comprehensive ALM review and asset allocation strategy.
In the past, the government could influence the way in which pension assets were deployed in the economy because of their influence over trust banks and life insurers, which had complete discretion over investment decisions. As a greater proportion of pension assets are given to investment advisers, whose decision-making is based on modern portfolio theory, this economic policy mechanism will have diminishing effect. We are still in a transitional period where external managers have more of an influence over a plan's investment policy as a result of sponsors giving them discretion over asset allocation decisions.
What does all of this bode for the investment policies and activities of Japanese corporate sponsors this fiscal year? Sponsors are expected to maintain a significant portion of their assets with their traditional managers, who have historically followed the 5-3-3-2 guidelines. Investment advisers are likely to increase gradually their market share as a result of their specialist approach to multi-asset-class management. Over time, as Japanese plan sponsors acclimatise to the brave new world and their newfound fiduciary responsibilities, we expect they will evolve more along the lines of the UK than the US, given their preference for leaving asset allocation decisions to their managers.
George Curuby is principal of Curuby & Company in Tokyo. The above is abstracted from a report just completed by Curuby & Company entitled Japan's Pension Market to 2005", available for $299 plus handling charges from ISI Publications in Hong Kong, tel: +852 2877-3417, fax: +852 2877-0942."