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Public Sector Proves More Prudent in Japan

By Barney Jopson, The Financial Times

February 16, 2004

Public institutions spend money, but only the private sector knows how to make it - or at least stop it disappearing down the drain. This is received wisdom, but Japan's pension system has turned the concept on its head.

The public pension system is certainly not a picture of health compared with its ailing corporate counterpart - both are struggling to meet payment obligations. The difference is that the public pension fund is modernizing its investment process and many private funds are not.

With assets worth more than Switzerland's gross domestic product, the Government Pension Investment Fund (GPIF) is the world's largest retirement fund. But despite its bulk, it is in the midst of a transformation orchestrated by Noboru Terada, the executive investment officer.

Since joining the Y40,000bn ($380bn) fund, he has taken advantage of deregulation to rationalize and professionalise the way it invests. In the process, the 68-year-old has become an icon for pension reform - one with many admirers but a disappointingly small number of followers at corporate funds.

Like Mr Terada, the pension plans at Japan's biggest companies are learning from US and European investment practice. But a mass of others show no signs of fighting their way out of insolvency - because they are as inflexible and lacking in motivation as the government organization that fell under Mr Terada's control.

After more than 40 years at the Nomura Research Institute and Japan's Pension Fund Association, Mr Terada in 2001 joined an organization that had just been released from the ministry of finance's stifling grip, but still bore the hallmarks of bureaucracy in the form of a loose and unsophisticated investment process.

He arrived as Japanese and global stock markets were sinking, and watched the fund post consecutive annual losses of 5.7 per cent, 2.5 per cent and 8.5 per cent. (This month he said it was on course for a positive return in the year to March).

During that time, the fund's asset allocation was similar to today's - 51 per cent invested in domestic bonds, 26 in domestic stocks, 13 in foreign stocks, eight in foreign bonds, plus cash - and politicians focused on that as the root cause of its losses.

One group even persuaded a government panel last year to consider whether the GPIF should be banned from investing in equities altogether. The idea was rejected, and Mr Terada kept moving the GPIF in the opposite direction.

He created a flurry of controversy last year by signalling the GPIF could soon invest in hedge funds. The GPIF's government bosses are debating the idea and Mr Terada emphasises that he has no detailed plan about when or how such investment could begin. But he told the FT earlier this month: "Alternatives, and particularly hedge funds, could contribute to our performance if used appropriately."

Hedge funds, though, would not be an exotic and isolated experiment. They would form one part of a plan to broaden GPIF's investment. "First of all we need to diversify within the classes where we are already invested," he says.

In each asset group at least 60 per cent of GPIF's investments have to be passive, but the fund also makes a point of hiring managers with different styles and records that are not highly correlated.

Bigger changes are ahead. With domestic equities, the GPIF invests in just the first section of the Tokyo stock exchange, but Mr Terada "would like to expand beyond that to the second section, Jasdaq and the OTC market". Overseas, he wants to spread money beyond developed economies into emerging market debt and equity.

To bond-loving politicians, Mr Terada's strategy means exposing pensioners' money to a new set of risks. But thanks to a more disciplined risk management system, he argues that "even if it appears we are taking more risk, we control the whole portfolio, so in aggregate there is no increase".

With investment managers themselves, the GPIF has shown how to be tough. It has cut the number of investment houses it uses, dropped local managers still employed by corporate funds out of habit rather than merit, and raised the proportion of assets allocated to foreign managers.

There is no pre-set preference for overseas houses, Mr Terada says. They just tend to come out on top of its performance, investment philosophy and professionalism assessments. "Local managers have inconsistent investment policies and few people with a lot of investment experience."

Consulting firms, whatever their origins, also win little praise. Mr Terada echoes concerns that many give advice that is unreliable, not adapted to Japanese circumstances and liable to lure naive pension funds into bad decisions.

The consultants GPIF used when Mr Terada arrived have all have been fired. In their place, he is training his staff to select managers and monitor risk. "At the start there was a bureaucratic feeling in this organization. People were very adverse toward new strategies," he says. "I've changed that."

What Mr Terada has done at the GPIF can, in many respects, be a model for private pension investment reform. But for companies sponsoring pensions, perhaps the most important lesson relates to their own personnel policies.

Inexperienced managers often end up in pensions divisions in distant parts of a business, and do not view it as the most prestigious place to be. The GPIF's experience shows that if plan sponsors want pension reform, they need to put qualified people in place.


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