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7/28/2019 GPIF - Ant, Grasshopper and Widowmaker
1/8J UL Y / AU G U S T 2 01 2 I NS T I TU T IO NA L I NV E S TO R . C O M
TTHE AIR INSIDE THE GOVERNMENT PENSION INVESTMENT FUNDSTokyo headquarters was as warm and dry as a spaceships. As president TakahiroMitani and his colleagues filed silently into an austere meeting room, I was sweatingslightly, struggling to compose my question with the correct level of Japanese politesse:How did the worlds largest pension fund decide on such a conservative level of riskand return for its portfolio?It was far from an idle question. The GPIF has 108trillion ($1.36trillion) in assetsunder management. Thats nearly six times as much as the California Public Employ-ees Retirement System, the biggest U.S. pension fund, and nearly four times as muchas Europes largest pension plan, Stichting Pensioenfonds ABP of the Netherlands.Even more striking than the funds gargantuan size is its composition: Fully three
quarters of the GPIF is invested in bonds, including 58.4trillion of domestic bondsand 14.4trillion of government agency debt.
Many large Western pension funds, led by pioneers like CalPERS and ABP, havechosen to reach for yield, a choice they know exposes them to big market swings. For
42/JAPAN
Japans giant government pension fund sitson a mountain of government bonds
a low-return and potentially high-risk strategy.
BY JAMES SHINN
Widow-maker
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GPIF president Mitani pursues a conservative investment strategy at the pension fund. Will it deliver the returns that Japans retirees need?
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some of these funds, the portfolio losses of 200809 were near-death
experiences (CalPERSs assets plunged 38 percent), pushing their
funding ratios down into the red zone. Yet most of these funds are
trying to grow their way out by continuing to bet heavily on equities
and making ever-larger allocations to private equity, hedge funds,real estate, infrastructure and other illiquid assets.
But not the GPIF. At the end of 2011, the Japanese fund had 67.4
percent of its portfolio invested in Japanese bonds, 11.1 percent in
Japanese stocks, 8.4 percent in foreign bonds, 10.1 percent in foreign
stocks and 3 percent in short-term assets. No exotic long-dated assets
anywhere. And fully 80 percent of the portfolio is invested passively.
The GPIFs financial conservatism is all the more striking con-
sidering its demographic challenge: Japan is starting to slide down
the reverse slope of an inexorable demographic curve. Forecasts by
the countrys National Institute of Population and Social Security
Research estimate that the number of people between 15 and 64
years old will nearly halve in the next 50 years, to 44.2million in2060 from 81.7million in 2010, even as the number of retirees swells.
Japans public pension system was basically a pay-as-you-go
defined benefit plan until the past decade, when Tokyo created the
GPIF and began a series of incremental reforms designed to put
the countrys pension system on a more sustainable basis, such as
increasing contribution rates and reducing benefits. Those measures
fall well short of whats needed to ensure that the GPIF will be able
to redeem the promises made to todays workers, though. Already,
the fund is paying out more in pension benefits than it receives in
contributions, an inflection point it passed in 2009.
The twin problems of government deficits and demographic
decline have seized center stage in Japans policy debate. All eyes are
on the GPIF and its massive pot of money, to see whether the fundcan generate adequate returns on its portfolio. This debate highlights
several policy trade-offs of deep interest to pension funds, money man-
agers and Treasury and Finance Ministry officials in North America
and Europe, where countries face the same dilemma of demographic
pressures and underfunded pension schemes. How Japan resolves its
debate is bound to shape global financial markets in a profound way.
Hence my trek to see Mitani-san. Why did the GPIF make its
conservative portfolio strategy choice? What political factors got
it there, and what governance structures keep it there? Who makes
money from the GPIFs strategy, and who might profit or lose
from a shift in the funds risk-reward profile? These were just a few
of the questions I hoped to get answers to.
JAPAN IS MY SECOND COUNTRY. I AM PROBABLY ONE
of only a few foreigners who breathe a sigh of comfort after coming
through Narita International Airport. Ive been visiting Japan for four
decades, lived in Tokyo for seven years and met my wife there. The
social clues and nuances, the linguistic indirection and politesse, are
second nature to me now. Tokyo is constantly being rebuilt physi-
cally, but the social infrastructure endures.
Visitors to Japan are struck by how well the physical infrastructure
works. One of my trader friends turned to me after a weeks sojourn
in Tokyo and asked, What part of this lost decades story am I
missing? Japan is supposed to be stuck in a permanent recession,
but the buildings are beautifully designed, traffic flows smoothly,everybody is well dressed and healthy, a Shinkansen [bullet train]
leaves Tokyo Central Station for Osaka every five minutes, and there
are more Michelin three-star restaurants in Tokyo than in Paris.
Hes right. The Michelin three-star count is Tokyo: 14, Paris: ten.
New York, by the way, has just seven.
One of the answers to this conundrum is concealed behind ananonymous gray door in Kasumigaseki, the government quarter of
Tokyo, which lies just south of the Imperial Palace. Kasumigaseki has
been the center of bureaucratic power in Japan for more than a cen-
tury. The Ministry of Finance and the Ministry of Economy, Trade
and Industry practically glare at each other across Sakurada-dori, the
avenue that bisects the district. These two ministries have competed
for sway over Japans economy since the end of World War II.
Once the unquestioned headquarters of Japan Inc., the serried
ranks of ministry buildings in Kasumigaseki are under siege figura-
tively and, since the March 2011 Tohoku earthquake, literally. As I
made my way to the GPIFs offices through a light March drizzle, a
noisy scrum of antinuclear energy demonstrators gathered outsideMETI. The demonstrators placards accused the ministry of flawed
regulation of Japans nuclear power industry. METI was basically
conflicted; it was supposed to be the safety regulator of the very
industry it was nurturing to reduce Japans dependence on imported
oil. The government is similarly conflicted on pensions. It wants
the GPIF to produce good returns, but it also needs to finance its
massive deficit cheaply, which means stuffing ever more Japanese
government bonds, or JGBs, into the pension fund.
Despite the antinuclear protest outside, there was no noise inside
the GPIFs offices, once I finally found them. The pension fund is
tucked away on the second floor of a nondescript building set back
from Sakurada-dori by a small brick plaza featuring one of Tokyos
omnipresent Takarakuji lottery kiosks an ironic scene-setter for avisit to a fund where nobody gambles with money. There isnt even a
receptionist on the second floor. You must ring up your interlocutor
from a phone on the wall of a small vestibule that feels as claustro-
phobic as an airlock. The offices are plain, and the head count is just
75, making the GPIF a seeming paragon of efficiency.
Once I made it inside the funds offices, Mitani and two colleagues
sat down with me, and we were brought the usual cups of green tea.
Thoughtful and gracious, Mitani had a distinguished career at the Bank
of Japan before joining the GPIF in 2010. He was flanked by Takashi
Jimba and Tokihiko Shimizu of the funds research department.
I noticed that Shimizu was holding an annotated copy of my Insti-
tutional Investorarticle on CalPERS (March 2012 Americas edition),
which described how the California pension fund was reaching for
yield in a bid to dig itself out of a funding hole. I was curious what the
three of them made of CalPERSs investment dilemma that was
the principal reason for my visit. They were curious about how Cal-
PERS was rethinking its own strategy. We consider them something
of a peer, said Shimizu. And we follow what they are doing closely.We went back and forth in a mixture of English and Japanese. I
Our basic directive is to safely
44/JAPAN
PREVIO
USSPREAD:OLDWOMEN:
TOSHIY
UKIAIZAWA/REUTERS;ALLOTHERS:
TOMOHIROOHSUMI/BLOOMBERG
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wanted to be precise and also to make sure of
my grasp of the financial idiom in Japanese,
so I went back and verified these quotes in a
subsequent e-mail exchange.
The GPIF has adopted a relatively low-risk, low-return portfolio strategy, I noted.
Some analysts say this is proper and prudent,
since the Japanese public has a low prefer-
ence for risk and since Japan has had low real
growth for the past two decades. Others sug-
gest that the GPIF is a long-term investor and
should be able to reap the higher returns from
higher-risk, long-term investments, and that
if you did so, it would reduce the annual pen-
sion contributions from the Japanese govern-
ment budget, which is already under pressure.
Which approach do you agree with?We at the GPIF take our guidance on our
risk-reward portfolio strategy from the minis-
ter, so we dont decide on the risk preference
ourselves, Mitani responded. But in any case,
our basic directive is to safely invest the GPIFs
funds to achieve the necessary long-term
return with the minimum exposure to risk.
THE ANT AND THE GRASSHOPPER
has a remarkably long history in Japan. Intro-
duced by Portuguese Jesuit missionaries,
Aesops fables first appeared in Japanese translation in 1593, and
they remain among the best-known moral texts. Generations ofJapanese children have been taught to identify with the ant who,
unlike the carefree grasshopper, worked hard in the summer to save
up food for the future. That principle has been ingrained in Japans
development philosophy for nearly 150 years. The government has
encouraged savings and channeled that money into the grand project
of modernization and industrialization since the Meiji Restoration.
Aesop, of course, ignored the distributional side of the allegory.
Not so Japans politicians and bureaucrats. For decades they have
used the GPIF and its predecessors as piggy banks to fund ambitious
public works and constituency-pleasing handouts. The financial
return on the pension portfolio was not a big concern.
MoF bureaucrats and Liberal Democratic Party politicians have
at various points in time used pension funds for industrialization,
to finance government debt and to prop up the price of the stock
market, says Gene Park, a scholar of Japanese financial policy and
assistant professor of political science at Loyola Marymount Univer-
sity in Los Angeles. Japanese officials are increasingly aware that the
goal of pension investments should not be to provide patient capitalor public finance but rather to ensure the solvency of the pension
funds themselves. Making this transition, however, has been neither
easy nor fully successful.For most of the postwar period, a large amount of Japans pension
savings was funneled into the MoFs Trust Fund Bureau. Much of
this money disappeared into the now-infamous Fiscal Investment
and Loan Program, or FILP, a sort of huge parallel budget largely
under the control of ministry bureaucrats. Politicians despised the
MoFs tight grasp over the FILP but loved to be the beneficiaries of
investments in their electoral districts. FILP became a source
of funds that the LDP used to respond to the demands of key con-
stituencies and coopt opposition issues, observes Park. Opaque
accounting, minimal oversight and lack of deliberation in the Diet
allowed the funds to be used easily for politically expedient purposes.
The marvelous public infrastructure that my trader buddy so
admired decades later is one of the fruits of the FILP. Airports, high-
speed trains, fiber-optic trunk lines, nuclear reactors you name
it. All fueled by low-cost capital. According to foreign observers
such as my friend Ezra Vogel of Harvard University, who penned
his influential bookJapan as No. 1 in 1979, this was a key feature
of Japans developmental regime: patient capital in the hands of an
invest the GPIFs funds to achieve the necessary long-term return
with the minimum exposure to risk. Takahiro Mitani, Government Pension Investment Fund
Pension financing challenges both Prime Minister Noda (left) and the GPIFs Mitani
MITANI:TOMOHIROOHSUMI/BLOOMBERG;
NODA
:HARUYOSHIYAMAGUCHI/BLOOMBERG
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efficient bureaucracy and patient capital
in the hands of efficient private enterprise,
joined in a high-growth, low-tax effort. That
was the magic formula.
Patient capital also fueled investment
in the private sector. As a junior banker at
thenChase Manhattans Tokyo branch
in the mid-70s, I was awed by Mitsubishi
Heavy Industries huge shipyards, Japan Steel
Works giant blast furnaces and rolling mills,
NEC Corp.s billion-dollar semiconductor
facilities and Toyota Motor Corp.s gleaming
new assembly plants. I was surprised by howfew of these investments were subjected to any
kind of return-on-capital threshold. Like the
MoF bureaucrats, the insurance companies,
trust banks and so-called city banks providing
the loans didnt waste much time on that sort
of detail back in Japans go-go years.
In retrospect, the countrys much-admired
development regime carried the seeds of its
own stagnation. When I returned to Japan in
the 1980s, working in the integrated-circuit
business, we Silicon Valley guys feared that
NEC, Fujitsu and other Japanese companies
were going to drive us out of business with
their patient capital and technical prowess.
And they did drive Intel Corp. and my one-
time employer, Advanced Micro Devices,
out of the dynamic random access memory
(DRAM) business. We retreated into the
microprocessor and telecommunications
segments, where we could make some money.
When I was in Tokyo in February of this
year, I picked up the morningNikkeiShim-
bunto read about the $5.5billion bankruptcyof Elpida Memory, the last Japanese manu-
facturer of DRAM. Elpida combined thememory operations of NEC, Hitachi and
other Japanese semiconductor majors in a
last-ditch effort to resist South Korean and
Chinese incursions into the market, powered
by South Korean and Chinese patient capital
and technical prowess.Efforts to shift away from the cheap-
capital-development model have led to a
decadelong tug-of-war between the bureau-
crats and the politicians, with pension funds
very much at the heart of the struggle. The
LDP wrenched partial control of pensions
away from the MoFs Trust Fund Bureau
and FILP in the 1990s, placing some funds
under the purview of the Ministry of Health,
Labor and Welfare. The Korosho, as the
Labor Ministry is commonly known, put the
money to work in Japanese equities and, to alesser degree, real estate. These first experi-
ments in diversification produced some nega-
tive results as funds were hammered by the
meltdown of the Japanese stock and property
markets in the 90s. But the LDP persevered,
finally pulling the entire pension fund away
from the MoF in 2001 and establishing the
first iteration of the GPIF. This was one pillar
of several epic reforms begun by former prime
minister Ryutaro Hashimoto in the late 90s
and pushed through early in the 2000s by
former prime minister Junichiro Koizumi.
Koizumi succeeded in a high-stakes gam-ble that included a successful referendum on
his reforms, but he made some compromises
with the LDP old guard and the MoF along
the way. The GPIF promised to continue to
stream funds into the FILP for seven years.
And the Korosho put together an expert
advisory committee to set the GPIFs port-
folio strategy. No surprise: Most of the funds
were more or less earmarked to finance the
government, a choice thats still reflected in
the GPIFs portfolio today.
Yet the GPIF did cautiously edge awayfrom its home-country bias a predilection
common to almost all national pension plans
and carefully began investing in foreign
equities and fixed-income securities. These
investments were invariably hurt by periodic
yen revaluations against foreign currencies,
particularly the dollar. The GPIF still bears
the scars from its first attempts at climbing
out onto the yield curve from the safe base of
JGBs. So do most Japanese citizens.
The foreign financial press often describes
the caution of the prototypical Japanese
everywoman saver, Mrs. Watanabe, sincethe bursting of the countrys financial bubble
in the 90s, and they are not far off on this. My
Japanese mother-in-law parlayed a modest
nest egg into a small fortune by playing the
stock market and reinvesting profits in Tokyo
real estate. She followed the Nikkei closelyand was an awesome stock picker. A famous
beauty in her youth, she charmed several
generations of branch chiefs at Nomura
Securities in Denenchofu, the tony Tokyo
suburb where she lived.
In the 1980s, when I was working in Sili-
con Valley and managing Advanced Micro
Devices Japan, she used to quiz me about the
prospects of various technology companies,
their stock prices circled in red pencil on
her dailyNikkei. But her ventures in foreign
stocks were disappointing as yen apprecia-tion clobbered her returns. She gave up on
foreign stocks in the mid-1990s.
THE GOVERNANCE STRUCTURE OF
Japans public pension system is a triangle.
The Korosho sits at the apex. The ministry
decides benefit and contribution levels, and
sets risk and return targets for the GPIF. The
fund, in turn, determines its strategic asset
allocation, but it entrusts most of the actual
money management to outside firms.
The purpose of this governance struc-
ture was to devolve responsibility for invest-ment management from the Korosho, which
was apt to be the target of political criticism,
explains Masaharu Usuki, a Nagoya Uni-
versity economics professor who sits on the
GPIF investment committee. As a result,
Japans pension system was less vulnerable to
reputation risk and political criticism during
the market turmoil of 200809 than it was
during the turmoil of 200002.
According to Yuji Kage, former chief
investment officer of Japans Pension Fund
Association: The Korosho reviews and recal-culates the long-term forecast of the financial
condition, the assets versus liabilities, of the
public pension fund every five years. In doing
so, another government committee of econ-
omists provides their forecast of economic
parameters, including the rate of long-term
investment return, which in turn is used as an
assumption for actuarial purposes. Kage was
careful to remind me that his comments are
strictly his personal observations.
Although the Korosho holds most of the
cards, the asset allocation process has seen
some modest devolution of authority tothe GPIF, with the fund given discretion to
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set parameter values for each asset classs
expected return and risk, and to select asset
classes for investment, says Nagoyas Usuki.
Yet many outside observers believe the
fund is excessively constrained by its Koro-sho masters. In a 2010 working paper, econ-
omists at the Organization for Economic
Cooperation and Development contended
that the GPIFs structure and investment
strategy did not comply with the OECDs
principles for public pension management.
The GPIF decision making is limited to
what has been authorized by the Minister
in charge i.e. it is not a fully independent,
segregated entity, wrote Fiona Stewart and
Juan Yermo, members of the OECDs finan-
cial affairs division. The governance struc-ture of the fund may therefore encourage its
low profile, seemingly low risk, conservative
nature, which may not be addressing risks
fully and certainly means that the potential
of the institution is under-utilized.
Not only does the GPIF have limited dis-
cretion in altering the portfolios risk budget,
its capacity to manage the funds is severely
limited by statute. In their zeal to avoid
bureaucratic empire-building, Japans pen-
sion reformers strictly limited the size and
compensation levels of the GPIF, forcing it
to outsource the management of 90 percent
of its market investments.
Keith Ambachtsheer, director of the Uni-
versity of Torontos Rotman International
Center for Pension Management, thinks this
strategic choice is suboptimal. The invest-
ment mandate, as well as the organization
and governance structure chosen for GPIF,
drives it toward a cost- and risk-minimizing
culture, he says. In contrast, countries
such as Australia, Canada, New Zealand
and Sweden have chosen mandates that are
driving their national reserve funds toward
high-performance cultures, marked by
organizational independence, expert inter-
nal investment and control capabilities, andperformance-based compensation schemes.
Ambachtsheer goes on to adumbrate the
benefits of the high-performance approach.
A return increase of 2 percent per annum
would increase Japans public pension
reserves by a highly material 1.6trillionper year, he says. Japan has built a justified
global excellence reputation in the design
and manufacture of consumer products.
Why not in fund management too?
Economies of scale was a concept that had
been drummed into me during my years in
Silicon Valley. Potential scale economies are
even more breathtaking in finance. Entities
like the Canada Pension Plan Investment
Board, as well as Dutch and Scandinavian
pension plans, have demonstrated as much,
earning great reputations for competentand cost-effective fund management. So I
took another sip of green tea and carefully
assembled another question for Mitani:
Some foreign pension funds are bringing
some asset management functions, such as
passive equity investments, in-house because
of economies of scale. With its huge size,
the GPIF has even more potential econo-
mies of scale if it performed more in-house
asset management. Are the Korosho and
the GPIF firmly committed to the current
low-cost, low-risk management approach?
We do some in-house passive manage-
ment of Japanese bonds, but we dont cur-
rently do in-house management of foreignbonds because of lack of organizational
skills and also because of operating budget
constraints, said Mitani. As for domestic
and foreign stocks, we are not permitted
to actively manage these assets by the pen-
sion law statutes. Overall we are required to
achieve the policy goals given to us by the
ministry with minimum risk and maximum
return while minimizing expenses.
Mitanis operation is low-cost, for sure.
The GPIF paid a total of 24.6billion inmanagement fees in the fiscal year ended
March 31, 2011 an astonishingly slim0.02 percent of fund assets. It spent 0.01
percent on the management of Japanese
bonds, 0.05 percent on the management
of both domestic and foreign equities, and
0.06 percent on international bonds. Mitani
is running exactly the kind of lean operationthat the Korosho wants. And it requires him
to depend on outside money managers.
At the end of March 2011, the GPIF
staff ran a total of 9.8trillion in two in-house domestic bond funds, 2.9trillionof near cash-equivalent short-term assets
and 18.2trillion of FILP bonds. The fundoutsourced management of the remain-
ing 85.4trillion of assets to 28 externalmanagers. The externals included a dozen
of Japans largest managers, led by Sumi-
tomo Trust & Banking Co. and Chuo MitsuiAsset Trust & Banking Co., and a virtual
whos who of big Western outfits mostly
U.S.-based such as BlackRock, Goldman
Sachs Asset Management and State Street
Global Advisors.
While it is possible that we could
decrease external management fees by
bringing more of the management of
Japanese bonds in-house, we are limited
in doing so by factors including possible
market impacts of the sheer size of our asset
holdings, concentrated operational risk and
operational budget constraints on the GPIFitself, said Mitani. The GPIFs midterm
policy guidance requires us to carefully
consider transactions and market scale so
as to avoid major market dislocation, price
distortion or excessive concentration. So
we move very carefully when rebalancing
our portfolio, in order to avoid these kinds of
market dislocations or distortions.
Kage agrees with this cautious assess-
ment. Even a 1 percent change in allocation
means a transaction of about $14billion,he notes. So its impractical for GPIF toconsider the same active investment strategy
as funds with $200billion to $300billion.Indeed, size is a major obstacle to accom-
plishing more-effective investment.
The GPIFs return benchmark is a bit
unusual for a pension fund: The Koroshos
guidance calls on the fund to beat Japans
annual growth in nominal wages by 1.1 per-
centage points. By this measure, the fund did
pretty well until quite recently. For the eight
years up until 2010, the GPIF produced
an average annual return of 2.43 percent,
while wages declined at an annual rate of0.55 percent welcome to Japans second
The governance structure of the fundmay encourage its conservative nature,which may not be addressing risksfully and means that the potential ofthe institution is under-utilized. Fiona Stewart and Juan Yermo,OECD
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lost decade. So the fund beat its benchmark
by almost 200 basis points a year.
But in the fiscal year ended March 31,
2011, Mitani and his colleagues had a return
of 0.25 percent. The portfolio took hitsof 9.04 percent on its holdings of Japanese
stocks and 7.06 percent on foreign bonds,
while domestic bonds were up 1.95 percent
and foreign stocks gained 2.18 percent.
From April through December 2011, the
latest figures available, the overall portfolio
was down by 2.54 percent. A gain of 2.58
percent in domestic bonds was more than
washed out by declines of 15.12 percent on
domestic stocks, 16.01 percent on foreign
stocks and 4.39 percent on foreign bonds.
Many economists like the idea of target-ing returns to nominal wages, asserting that
in the long run it is unrealistic to expect
returns on financial investments to exceed
the underlying growth rate of the economy.
But many financial professionals are taken
aback by the unusual benchmark.
While actuarially speaking, such a long-
term goal makes sense, from the perspective of
an investment manager such a target needs to
be translated into returns that can be obtained
from market instruments, the OECDs Stew-
art and Yermo wrote in their report. GPIF
cannot be evaluated for missing a target that isultimately outside its control (wage growth).
Yet the OECDs criticism may miss a
more important public policy point. By using
real wages as a benchmark, the Korosho and
the GPIF are avoiding the kind of unrealistic
targets that have led so many other public
pension funds into wishful-thinking terri-
tory. A recent survey by Wilshire Associates
showed the average U.S. public pension fund
had a target return that was at least 1 percent-
age point above realistic expectations.
Indeed, for skeptics of the so-called Yale
model of reaching for yield, currently fol-
lowed by most U.S. public pension funds, the
GPIF is an admirable example of a liability-
driven investment, or LDI, approach to pen-sion fund management. The LDI catechism
states that the risk, return and maturity pro-
file of the pension funds assets should match
the risk, return and maturity profile of its
liabilities. Because Japanese retirees claims
are known with actuarial precision, an LDIadvocate would argue that the GPIF should
fund these claims with an amount of JGBs
or other risk-free assets that matches the
maturity of these future pension obligations.
Kage makes a strong case for the GPIFs
conservative strategy. So long as public
funds ultimately are governed by the govern-
ment, which is controlled by representatives
of the general public, risk tolerance is subject
to the general publics risk tolerance, and the
general publics risk tolerance is not neces-
sarily high, he explains. If and when thestock market collapses and performance
goes negative for some time, people, the
media and politicians will complain loudly.
For sure, both the archetypal Mrs. Wata-
nabe and my real-world mother-in-law have
a low tolerance for volatility at this point.
If it were explained to them in common-
sense terms, theyd probably concur with
the GPIFs conservative strategy.
But is there another, deeper risk buried
inside the GPIF portfolio?
Kyle Bass of Hayman Capital Manage-
ment thinks so. A vocal JGB bear, Basscompared Japans fiscal situation to Bernie
Madoffs Ponzi scheme, speaking at the Uni-
versity of Virginia Investing Conference in
November 2011. You dont have to live
up to any of the promises that you make as
a government or as an investment manager
as long as you continue to have more people
entering your scheme rather than exiting,
he said. Thats no longer the case in Japan,
he noted. The population is in a state of
inexorable decline. And what that means
is that you will begin to have more people
dissaving than saving. Thats an ominous
development for a government that needs
to sell bonds to banks, insurers and pension
funds to finance its massive deficit.The scale of Japans government debt is
huge. According to estimates by Torsten
Slok, an economist at Deutsche Bank, the
MoF will issue bonds in the amount of nearly
60 percent of GDP this year to finance the
deficit and roll over maturing debt.If Bass is right, the GPIF is exposed to a
huge capital gains risk on its JGB portfolio. A
couple of basis points uptick in the rates that
the government must pay on its mountain of
debt ten-year JGBs were yielding just 0.83
percent last month would blow a huge
hole in the MoFs annual budget.
I queried Mitani about this in our follow-
up e-mail exchange: Some analysts suggest
that with Japanese government debt growing
above 200 percent of GDP there will be a
crossover point, called X-day, when the yieldon JGBs will increase suddenly, causing large
losses for holders of JGBs, such as the GPIF.
A recentAsahi Shimbunreport said that Mit-
subishi-UFJ was planning for a 2016 X-day
contingency. What steps have the GPIF and
the ministry taken to insulate the savings of
Japanese pensioners from the potential port-
folio losses of an X-day-type event?
The fund president didnt seem too con-
cerned. Generally speaking, a sudden rise in
JGB interest rates would cause GPIF a capital
loss, he responded in an e-mail. On the other
hand, higher yields on the JGB portfolio wouldincrease our current income. Either way, it
wont change our basic portfolio strategy.
By contrast, the critical OECD authors,
Stewart and Yermo, took the GPIF to task
over this issue. Is the GPIF really consider-
ing the risk which its huge holding of JGBs
represents, which the OECD considers real
given the rising level of public sector debt
even with the countrys strong home bias
and domestic funding ability, or is it just
assuming that this is a low-risk portfolio?
they wrote in their report.Financial professionals in Tokyo and
around the world see a JGB interest rate
inflection point coming sooner or later.
According to one Hong Kongbased trader
friend of mine: Its not a matter of if . Its
a matter of when. That said, shorting the
JGB market is also referred to sometimes as
a widow-maker trade.
The worlds trading flows are strewn
with the bodies of traders who have made
that bet and lost it again and again, says
Thomas McGlade, head of U.S. operations
at London-based hedge fund firm PrologueCapital. As Hemingway famously wrote, a
The population is in a state ofinexorable decline. And what thatmeans is that you will begin to havemore people dissaving than saving. Kyle Bass, Hayman Capital Management
74/JAPAN
7/28/2019 GPIF - Ant, Grasshopper and Widowmaker
8/8I N S T I T U T I O N A L I N V E S T O R . C O M J U LY / A U G U S T 2 0 1 2
man goes broke slowly, and then all at once.
Japan is clearly going broke slowly, but we are
not currently at, and may be years away from,
Japans all at once moment.
Japans grim fiscal outlook is deeplyentwined with its pension fund management
problem. The money to fund the govern-
ments deficit, pick up its share of pension
benefits and pay interest on the JGBs already
stashed inside the pension fund all comes
from the same tax pot.
Every time a new prime minister is
selected in Tokyo, there is a fierce battle for
his soul. On one side hand-wringing MoF
mandarins tell him that without an increase
in revenue and control over expenses, the
budget is busted and X-day looms ever
closer. They usually propose an increase
in the consumption tax to plug the gap. On
the other side the prime ministers advisers
tell him that a consumption tax increase istantamount to political hara-kiri. For the
moment, the mandarins have convinced
Prime Minister Yoshihiko Noda of the wis-
dom of doubling the consumption tax, to 10
percent, to fund the pension system. Ichiro
Ozawa, a key power broker in Nodas Demo-
cratic Party of Japan, and other rivals in the
Diet are maneuvering to bring the prime
minister down on precisely this issue. The
consumption taxpension funding problem
may have become, like Social Security in the
U.S., a high-voltage political third rail.
Potential fiscal policy changes may drive
future public pension fund reform, says
former pension group CIO Kage. Japanese
government debt is approaching 200 percent
of GDP, and although Japans interest rates
are the lowest in the world, this situation will
not continue forever. Inevitably, the gov-
ernment will start to consider changing its
policy, expecting a higher return on public
pension fund assets in order to reduce the
government budgetary support.
A pension fund trustee has some hard
choices. In the case of a private defined ben-efit plan, trustees may choose to prioritize
plan beneficiaries and reach for yield if they
can put the downside risk of volatility
back to the plan sponsor. If they lean instead
toward the sponsor, the trustees will want
to minimize the plans exposure to volatilityby either funding it fully with low-risk assets
(which is expensive) or converting it from
defined benefit to defined contribution.
For a national public defined benefit plan
like the GPIF, there is no real choice. The
trustees could prioritize beneficiaries and
go for yield, putting the volatility risk to the
government, but that would only be an illu-
sion. The risk ultimately ends up in the lap
of the taxpayer, who has to fund the plan and
plug any gaps caused by volatility.
This dilemma raises a nettlesome ques-
tion: To whom does the GPIF board owe its
fiduciary responsibility pension beneficia-
ries or Japanese citizens as a whole?
If ensuring higher risk-adjusted returnswere its prime mission, the GPIF would start
to invest more heavily in offshore equities,
particularly in emerging markets, as well as
in other high-yielding assets to maximize
returns and absorb the volatility that comes
with that territory. But this portfolio adjust-
ment would force the Japanese government
to pay higher rates on its debt; that means it
would have to tax its citizens more and go
even further into debt, placing more of a
burden on future citizens.
Who exactly is responsible for the futurepayment of benefits? says Kage. Those
who make the promise today may not be the
people to actually deliver on the promise in
future decades. It is much easier to make a
promise that somebody else is supposed to
carry out. Here the future generation is not
in a position to sign the contract at all. This
is the critical agency problem.
THE DAY AFTER I CALLED ON
Mitani at the GPIF, I visited my mother-in-
law at her new assisted-retirement home,
the Wellina O-Okayama. I was still tryingto figure out whether the GPIF was a struc-
tural defect or a structural advantage for the
management of Japans economy, and how
that translated into the optimum portfolio
strategy for the funds 108trillion in assets.Looking up from my notes, I realized how
old everyone on the train looked (although
maybe I was just projecting my own preoc-
cupations onto the passengers). Old, yes, but
well dressed. Almost all of them were either
napping or texting on their cell phones. And
some of the ladies my age looked exception-
ally well put together.
My mother-in-law is 90 frail but sharp
as a tack. She is pleased to be in the Wellina,
recently built by Tokyu Group across the
street from its O-Okayama hospital. As I left
her room, I noticed a copy of that morningsNikkeinewspaper next to her pillbox, with
something circled in red.
The Wellina is beautifully designed, with
wood-paneled hallways, a lovely garden and
a relentlessly pleasant staff of caregivers,
many of them retired personnel from Japan
Airlines Co. I was so impressed that I told the
reception staff on my way out that Id like to
make a reservation for my wife and me to
move into the Wellina in March 2032.
They seemed to find that very funny.
But I was serious. There are few better
places in the world to grow really old in thanJapan. Both the physical and the social infra-
structure are wonderful. Im sure the staff
will be indulgent with the cranky old Ameri-
can with his cane and foreign accent. In any
case, my oldest son is a physician in Tokyo
and will keep me on my meds. And may even
help me cash my retirement checks.
In this sense, the Japanese are way ahead
of us all in planning for the realities of aging,
just as they have encountered the hard edge
of deflation and demographic reversion
before the rest of the developed world. Lets
hope they figure out how to solve the pension
strategy conundrum too. Because were all
headed down the same road.
James Shinn ([email protected] ) is a lec-
turer at Princeton Universitys School of Engi-
neering and Applied Science. After careers on
Wall Street and in Silicon Valley, he served as the
national intelligence officer for East Asia at the
Central Intelligence Agency and then as assistant
secretary of Defense for Asia at the Pentagon. He
is chairman of Teneo Intelligence and serves on
the advisory boards of Oxford Analytica andCQS, a London-based hedge fund.
Inevitably, the government willconsider
changing its policy, expecting a higherreturn on public pension fund assets inorder to reduce budgetary support. Yuji Kage, former CIO, Pension Fund Association