Japanese LPs: The end of the beginning

The call for applications for alternatives managers in April from Japan’s Government Pension Investment Fund (GPIF) – following more than four years of speculation and consultation – was met with eager expectations in the private equity industry. The fund’s JPY145 trillion ($1.3 trillion) in assets make it by far the world’s second-largest public pension manager behind the US Social Security trust fund, and GPs are excited at the prospect of even a fraction of that capital making its way to market.

Interest was also piqued at the country’s corporate pension funds, many of which have tracked the alternatives space for some time but were held back by Japan’s conservative culture. GPIF’s entry into the space eases the way for those that swim in its wake.

“The corporate pension boards had been saying, ‘Why should we do private equity or hedge funds when the large guys who are supposed to be the more legitimate pension funds, like GPIF, haven’t touched anything?’” says Hidekazu Ishida, a chief advisor at advisory firm System2 and former investment officer at Osaka Gas Pension Fund. “The cost of running a professional investment team has been high over the last 10-20 years, because the investment business is so small. But now that’s not going to be a problem.”

If they make a single mistake, people make a huge deal out of it, but when they make a good investment, no one pays any attention – Tuck Furuya

Despite their excitement, industry professionals caution that GPIF’s arrival will not cause an immediate transformation in the market. The fund took years just to get to the point of requesting asset managers and is likely to continue moving slowly as it builds its team and implements a strategy initially focused on fund-of-funds. Corporate pension funds, meanwhile, will face similar challenges building up their own long-neglected PE desks. GPIF might be seen as a game-changer, but investors must be prepared to keep playing by the old rules for some time to come.

Sizeable allocation

GPIF is authorized to invest up to 5% of its assets in alternatives, but as of December 2016 had committed just 0.07%. If it invested the full 5%, that would represent an enormous JPY7.25 trillion in fresh capital entering private equity, infrastructure, private debt, and real estate.

This gives GPIF heft in the market, but also works against it in some ways. Any loss, like the JPY5.3 trillion shortfall for the year ended March 2016, is guaranteed to stimulate criticism of the fund’s management of public money. And since GPIF must disclose its investment activity, it is vulnerable to second-guessing and pressure to follow a low-risk, conservative path.

“If they make a single mistake, people make a huge deal out of it, but when they make a good investment, no one pays any attention,” says Tuck Furuya, co-founder at domestic placement agent Ark Totan Alternative. “I think they are going to invest as if they can’t make one mistake, so that’s one reason why it’s taken so long.”

This ingrained conservatism is a common lament among investor relations professionals targeting the Japanese market. The capital managed by the country’s corporate pension funds has been estimated at up to $700 billion – a fraction of that available to GPIF, but still a significant prize for GPs to capture.

However, these institutions have historically been reluctant to consider private equity due to the higher perceived risk of the asset class, preferring to keep their investments in bonds and equities. GPIF is no exception, with domestic and foreign bonds representing 47% of its assets under management as of December 2016 and the same amount allocated to foreign and domestic equities.

Exceptions to this rule have begun to emerge, with market watchers citing the disappointing yields on Japanese bonds as an impetus for investors to seek better-performing assets. Introducing PE into the mix is seen as one way to boost returns and meet the fund targets.

“The allocation to private equity is still pretty small, and not everyone is participating. But some of the more sophisticated pension funds are shifting toward private equity,” says Kazushige Kobayashi, a managing director with Capital Dynamics. “For example, last year we got a mandate from a corporate pension fund in Osaka for a separate account with JPY5 billion to invest in Japanese private equity.”

Taking it slow

Individual corporate pension funds are unlikely to inspire others to follow their example, however, particularly on such a small scale. That role must fall to a player like GPIF, which is seen by many pension fund managers as a weathervane for their industry. With its massive size and reputation for avoiding risk, the fund can give other LPs the cover to take their own steps into a new asset class.

“If GPIF is comfortable with the risk of alternatives, a corporate pension fund in Nagoya can be too,” says Niklas Amundsson, a partner at placement agent Monument Group. “Japan inherently is a very conservative culture, so as long as I do the same as the government, my job is going to be safe. And I think that being safe is probably the most important thing at this point in time.”

Of course, not all pension funds are equal, and the vast majority of Japan’s corporate pension plans are too small to be able to participate in the private equity market to any meaningful extent. Larger players, such as automotive giants Toyota and Mitsubishi, are considered the most likely to follow GPIF into alternatives. Key to their motivation is their size and investment mandate, which affects their return target and makes the government fund relevant to their thinking in a way other large LPs, such as Japan Post Bank, are not.

“In our contact list, we have a couple of hundred major corporate pension funds. Not all of them are active in private equity investment just yet, but I believe when GPIF begins to make actual investments many of them will start considering private equity,” says Ark Totan’s Furuya. “But it has to be GPIF, not just Japan Post Bank, because Japan Post is not a proxy to conservative pensions.”

GPIF will remain conservative as it develops its alternatives strategy. The call for applications in April specified fund-of-funds across global private equity, global infrastructure, and global and Japanese real estate. Industry professionals attribute this approach to GPIF’s desire to keep its risk low while building up experience in the asset class.

This strategy will likely insulate the fund from risk, but it also means that the capital will take time to filter into the PE market. Commitments are also likely to be spread across multiple fund-of-funds, segregated by geography or strategy, in order to avoid overexposure to any one area. Because of this, most of the capital will not be available for direct investments until the fund-of-funds have had a chance to make fund commitments of their own.

For corporate pension funds not currently involved with private equity, the coming period is also likely to require caution. They will need time to build up their investment teams much as GPIF and Japan Post Bank have done. In addition, the government-mandated employee pension fund, previously managed by corporate pensions, is currently being transferred to GPIF, further inflating its assets but also meaning that a significant part of the capital managers had hoped to put into alternatives will not be available.

“Corporate pension funds are now not so well-staffed, and I think they are mostly doing fund-of-funds,” says System2’s Ishida. “It’s ironic that the practitioners at the corporate pension funds have been waiting for this moment for a long time, and when it finally arrives we don’t have the money to invest anymore.”

Evolving approach

Investment professionals expect GPIF’s approach to evolve with time. While initially the pension fund plans to invest through separate asset managers and fund-of-funds, increased comfort with alternatives risk may bring a change to its investment style, with GPIF taking over investment decision-making from the asset managers. Investments in individual PE funds, bypassing the fund-of-funds, would logically follow.

Even after GPIF graduates to fund investments, however, its size means it will most likely continue to invest in prominent global players rather than supporting local GPs. The corporate pension funds, which are considered more likely to seek domestic asset managers, are expected to make a bigger impact on the Japanese PE market.

Moreover, despite its initial global focus, GPIF has the potential to stimulate offshore GPs’ activity in Japan as well. While at first their interest will be drawn by the biggest player, once private equity firms are in Japan to court GPIF they can be reached by smaller players that they might otherwise have overlooked.

“Even if the corporate pensions start investing in private equity funds it’s not going to be that big, so the big blue-chip fund-of-funds might never even come to Japan,” says Furuya. “But now that they’re coming to meet with GPIF, they can take time to meet with the corporate pension funds as well. So I think there’s a good synergy effect there."

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• Topics
• North Asia
• LPs
• Fundraising
• Japan
• Government Pension Investment Fund (Japan)