Does the Japanese pension system need a complete overhaul in its investment mix and objectives?

Bloomberg News reported on March 06, 2014 that Japan’s Government Pension Investment Fund (GPIF) has been urged by a government advisory panel to adjust its investment indicators to include wage growth when setting overall investment goals, as its previous model of focusing on domestic bonds, or the Japanese Government Bonds (JGBs) might not serve as an useful forward indicator as the pace of inflation quickens. The core Consumer Price Index (CPI) released last week showed an unchanged 1.3 percent for the month of February 2014, as compared to the previous month. The increase in the core CPI is one of the monetary policy tool used by the Bank of Japan, as it seek to time its bond purchases so as to achieve its overall inflation growth of 2.0 percent by the second half of 2015.

According to the Mar 06 Bloomberg News article, the total net worth of the investment portfolio managed by GPIF is currently standing at approximately Japanese Yen (JPY) 128.6 trillion (USD 1.26 billion). This amount of investable assets held by the GPIF is quite significant, given that other Western nations, including the United States Government will long to have a huge war chest to deal with its budgetary issues.

The Government Advisory Panel has also urged the GPIF to adopt new investment goal objectives, including its annualised 1.7 percent total return target, combined with the rate of pay increases for workers. When summed up together, the Advisory Panel has worked out a long-term growth forecast of 4.2 percent, while also keeping the rest of its objectives, including credit ratings, term to maturity for its fixed income portfolios, and the makeup of its investment portfolio so as to enable the fund to at least have a long-term investment goal target that is realistic, and be sustainable as well. This also means that the GPIF should increase its exposure to other asset classes apart from just purely Japanese Government Bonds (JGBs). Nevertheless, the overall investment objective context has to be adhered strictly based on the investment mandate, and any straying of its investment goals is bound to have a detrimental impact to the overall corporate standing of the fund.

The latest Government Panel advisory comes at a time when Japan is just starting to see some signs of positive inflation at a time when deflationary conditions has previously been hampering much of Japan’s economic progress. The GPIF has been urged by the Panel members to be forward looking, and be prepared to root out or reduce its exposure to assets that are prone to be negatively correlated with the yields of its fixed income holdings. The wage models are to be used as part of the future indicators by the GPIF, as it better reflects to the pace fiscal and monetary reforms that currently being implement across the board under Prime Minister Shinzo Abe, and the Bank of Japan’s policy of ‘flooding’ the market with liquidity, thus weakening the Japanese Yen currency values.

The GPIF has so far been returning an average of 2.8 per cent over the course of nine years through March 2013, as compared to an average of 7.3 percent for the California Public Employees’ Pension System (Calpers). The advisory committee has also provided eight scenarios for Japan’s economic outlook, with the implied 4.2 percent built into it, and is made up of 1.7 percent target, together with total employee compensation of 1.3 percent, and inflation of 1.2 percent, which are quite reasonable, considering that wage growth is gradually making inroads despite the lack of or dismal progress in the track record in achieving some of the economic targets including Gross Domestic Product (GDP) growth, exports growth, and other economic indicators.

In summary, the Japanese government pension system is setting precedent in its investment advisory role, urging pension officials to focus on wage growth on a long-term basis, and not solely on its fixed income portfolio. I believe that the GPIF will not be straying from its previous focus on domestic bond holdings. It is still in line with the fund’s overall investment goals, but on a long-term basis, there is a need to review all the necessary economic measures that will ensure that there is preservation of capital, and such investments continue to bring about sustainable returns.

About Hock Meng Tay - Chief Editor, Asia-Pacific Region

Hock Meng Tay, CAIA has written 181 post in this blog.

Chief Editor, Asia-Pacific Region Hock Meng Tay is a CAIA holder and is currently taking CFA qualification. He has over 10 years of experience working as research associate in several investment companies.He is an expert in financial analysis and has published research reports in his current role. He obtained his Masters of Business Administration in Integrated Management and Masters of Arts in Economics while serving his internship in Starsource Inc

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About Hock Meng Tay - Chief Editor, Asia-Pacific Region

Chief Editor, Asia-Pacific Region Hock Meng Tay is a CAIA holder and is currently taking CFA qualification. He has over 10 years of experience working as research associate in several investment companies.He is an expert in financial analysis and has published research reports in his current role. He obtained his Masters of Business Administration in Integrated Management and Masters of Arts in Economics while serving his internship in Starsource Inc

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