Reference | FYI


GPIF investment shift could bring either bonanza or bust

by Atsushi Kodera

Staff Writer

Friday’s announcement of changes to the massive ¥127 trillion public pension fund’s investment policy was headline news.

The reforms mean more money will be used to buy stocks, which will likely lift the market — at least in the short term.

The shift to more riskier assets by the Government Pension Investment Fund — the world’s biggest retirement pool — is aimed at boosting its returns. And if the action enlivens the stock market, it would support the economy at a time when Prime Minister Shinzo Abe’s package of stimulus and adjustments known as “Abenomics” appears to be running out of steam.

But what often goes overlooked is the risk of mismanagement of the fund, which arguably represents the entire population’s future livelihood: Bad investments could result in workers making heavier contributions or beneficiaries getting reduced payments.

Here are some of the facts behind the reforms and the risks involved:

Where does the GPIF’s money come from?

The GPIF manages investments by both the contributions pool for the National Pension (Kokumin Nenkin) system, to which all registered Japanese residents are required to contribute, and the Employees’ Pension Insurance (Kosei Nenkin) system, which provides the earnings-linked payouts for company employees on top of what the National Pension pays.

What is the ¥127 trillion pool used for?

The public pension systems are structured in such a way that contributions from the paying population are immediately channeled into payments to existing pensioners, rather than being saved for the contributors’ own future payouts.

The GPIF dates back to the time when finances were sufficiently robust to build up a pile of ballast. However, as the number of contributors has decreased in line with the declining birthrate and beneficiaries are living longer thanks to better health care, the pension system has dipped into this pool to cover shortfalls. This is expected to continue and, if left unattended, could deplete the pool.

What is the main thrust of GPIF reform?

A major change is that of an investment tilt from domestic bonds to both domestic and foreign stocks.

As a key source of savings for Japan’s snowballing social security costs, the retirement fund has traditionally erred toward safety by investing chiefly in domestic bonds, which are considered low-risk assets.

The GPIF has now set its basic asset allocation target for bonds at 35 percent, reduced from 60 percent, while stocks will comprise 25 percent, up from 12 percent. Foreign bonds will rise to 15 percent, up from 11 percent, while foreign stocks will make up 25 percent, a jump from 12 percent before.

The government declared it will pursue these changes and seek more flexible management of the fund in its revised growth strategy, which was unveiled June 24.

The Abe Cabinet wants the GPIF to seek higher returns on its investment by increasing the allocation of stocks and through nimbler fund management. This will help cover growing payouts to the graying population while contributions shrink.

Abe has spoken widely of these changes. At January’s annual meeting of the World Economic Forum in Davos, Switzerland, he said the GPIF “will contribute to investments leading to growth.”

What other benefits do the reforms bring?

A massive flow of funds into stocks may boost the market, and therein lies investors’ interest.

A simple calculation shows that raising the ratio of stocks in the ¥127 trillion pool by just 1 percentage point would channel more than ¥1 trillion into the market. Increased buying of this magnitude is expected to boost stock prices, in turn helping to buoy the economy as a whole.

Seeking higher returns seems a good thing as it can mitigate the fund’s deteriorating finances and help improve its ability to pay pensioners.

What are the potential drawbacks?

By investing more in stocks, the GPIF can seek to increase gains by capitalizing on an asset class that provides a greater potential return than bonds.

But stocks are riskier and more volatile. Critics warn that market volatility could harm the fund’s balance sheet.

In other words, the GPIF is seeking higher returns by taking on greater risk.

How vulnerable is the pension system?

Based on 2002 statistics by the National Institute of Population and Social Security Research, the ratio of people aged 65 or older to those aged 15 to 64 was about 11 in 1960. This means roughly 11 people were covering one pensioner’s income.

The ratio is expected to shrink to about 2 in 2020, and then to less than 2 in 2050, weighing increasingly heavily on pension finances.

The situation calls for either increasing the burden on the contributors or cutting benefits, or a combination of both.

The welfare ministry, for example, is considering requiring National Pension participants to continue paying contributions until the age of 65, beyond the current upper limit of 60, NHK reported Oct. 26. The ministry expects more people to be retiring at 65 rather than 60, as companies are now required to raise the retirement age in phases to 65 for employees who desire to work longer.

If the GPIF invests more in stocks, what can it do to guard against investment failure?

The way the GPIF organization is currently structured, investment decisions ultimately fall to the president, currently Takahiro Mitani.

Although the fund has an investment committee comprising academics and market experts, that body only advises on investments, which critics say is insufficient to maintain the independence and effectiveness of decisions involving the GPIF’s massive public holdings.

That criticism is being heard. The latest reform calls for introduction of a “governance council” under the investment committee, which would have responsibility for monitoring the fund’s investments.

Welfare minister Yasuhisa Shiozaki is reported to have been pushing for a new structure in which investment decisions are made by consensus among an appointed group of experts. He wants to give the responsibility of decisions to a body modeled after the Bank of Japan’s Policy Board, which decides the course of the nation’s monetary policy by consensus.

In addition, the GPIF has appointed a compliance officer who will monitor whether the fund is meeting its stated investment principles, periodically reporting findings to the compliance committee.

The fund has also introduced measures to enhance its risk management, including hiring consultants versed in macroeconomic analysis and market forecasts.

But Banri Kaieda, leader of the Democratic Party of Japan, on Saturday criticized the latest GPIF reform as an “attempt at boosting stock prices just to give the impression that the Abenomics economic policy is succeeding” when indications are that it is losing steam.

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