Japan’s Government Pension Investment Fund (GPIF) is considering the addition of alternative investments to its portfolio. It must find a balance between conservatism and the need for higher returns
Is the world's largest public pension fund going to enter the private equity space? We may find out over the course of 2013 as Japan's Government Pension Investment Fund (GPIF) considers its options. With more than JPY108 trillion ($1.31 trillion) under management, a 10% allocation to private equity would see $131 billion enter the market. To put that in context, California Public Employees' Retirement System (CalPERS) - one of the world's largest PE investors - currently has $32.1 billion committed to the asset class out of its total pool of $242.7 billion.
It is unwise to overhype the GPIF's potential involvement. For a variety of practical, political and fiduciary reasons, the fund is rarely able to move quickly.
"There is a lot of debate in Japan as to whether public pension schemes should start investing in alternatives," says Tokihiko Shimizu, director-general of the research department and investment policy actuary at GPIF. "Some government ministers say we should be able to invest in private schemes such as infrastructure in India and China; others say the priority should be safety. It is very controversial."
Even if approval for an alternatives program came tomorrow, the sheer size of GPIF's asset base doesn't encourage drastic action; it would take years to build up meaningful exposure. Korea Investment Corporation (KIC) spent three years ramping up its PE exposure to $10 billion after launching its program in 2009, and GPIF is unlikely to be so aggressive in its approach.
A revised allocation?
As it stands, the Japanese fund has about two thirds of its assets in domestic bonds, as required by the government. The remainder is divided up between domestic equities (11%), foreign equities (12%) foreign bonds (9%) and cash (4%). It was only in June 2012 that GPIF started including emerging markets in its foreign equities exposure.
A feasibility study on whether alternative investments - private equity, infrastructure and real estate - should also appear in the portfolio began last autumn and the groups tasked with carrying it out are due to report back in March.Local law firm Atsumi& Sakai, Capital Dynamics, independent PE consultancy Brightrust and T&D Asset Management, a subsidiary of a domsetic insurer, were chosen for the task.
Shimizu admits to studying the alternatives strategies of a number of other pension funds globally, including Canada Pension Plan Investment Board (CPPIB), Denmark's ATP, Temasek Holdings, and the Government Pension Fund of Norway. One key area of difference is direct investment - an increasingly attractive option for many institutional players yet an area that is currently off limits to GPIF because it is prohibited from investing in equities directly.
"However, alliances are possible," Shimizu observes. "For example, GPIF could form an alliance with another pension fund and it could make direct investments."
As for returns, the fund is expected to deliver an annual yield that exceeds nominal wage increases by 1.1% in the long term. It delivered a 2.42% annualized return between 2003 and 2011, a period during which wages declined by 0.51%. With this in mind, Shimizu thinks the long-term stable cash flow generated by infrastructure and real estate would be a good fit for GPIF.
It is worth noting that, since 2009-2010, the fund has been paying out more in benefits than it receives in contributions. With a the first wave of Japan's baby boomers about to reach 65 and qualify for full pension benefits, the fund wants to build up a JPY8.87 trillion cash reserve.
GPIF's return for July-September came to 0.49%, compared to a deficit of 1.85% in the previous quarter, adding JPY528.7 billion to the coffers. However, the six-month return of 1.39% still trailed CalPERS and CPPIB, which posted gains of 3.4% and 2.4%, respectively.
While GPIF is under pressure to generate capital for rising payout demands, it remains a conservative investor. The situation isn't helped by negative public perception of private schemes. Domestic institutions have been backing away from local PE firms, disillusioned by the underperformance of the major buyout funds, and the fraud scandal at AIJ Investment Advisors, which sparked concerns about opaque investment vehicles.
Above all, GPIF has to bear in mind that where it treads, others will follow. Japanese pension funds had more than $3.3 trillion under management at the end of 2011, about 60% of which was held in bonds, according to Towers Watson. The country's top 10 funds account for nearly two thirds of total pension assets, compared to just 8.4% in the US, largely because of GPIF's dominant position. Smaller operators look to it for guidance, which means a GPIF decision to participate in PE could release a significantly larger pool of capital into the market.
"There are a lot of small pension funds all over Japan, not only corporate plans but also on the public side, and they are unwilling to take the risk," adds a local pensions expert, who asked not to be named. "If they do it wrong then their bosses will say, ‘Why are you investing in private equity? GPIF isn't doing it. This is a big issue."
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After a decade-long mining boom the economy is experiencing a loss of momentum and the resulting deal flow reduction and lack of value in the market means GPs are chasing many of the same acquisition targets. That said, the exit market is recovering with both IPOs and M&A activity picking up, and an increase in LPs appetite for the asset class, and the recent government change means that the industry is cautiously optimistic for the future and expecting a rise in activity over the next 12 months.
5-7 March 2014, Four Seasons Hotel, Sydney