The Pension Fund Association (PFA) of Japan is a pension benefits provider for employees who seceded from employee pension funds after a short term of membership. PFA aggregates a variety of corporate pension plans, including employee pension funds, defined benefit corporate plans, and defined contribution plans. The Association also engages in secure and efficient management of assets that serve as financial resources for pension benefits. How does PFA, an asset owner known for its sophisticated management, handle its nearly JPY 12 trillion in AUM?
Approach to Investment Management
PFA applies five basic presumptions to pension asset management: 1) market returns are unpredictable, 2) risk premiums exist, 3) fluctuations in reserve levels are a risk, 4) equity is the source of risk and return, and 5) alternative investments are intended to diversify alpha sources.
When formulating our policy asset mix, asset allocation is not based on an active outlook. PFA believes long-term management is rewarded via risk premiums and formulates its policy asset mix based on long-term intrinsic value. PFA does not reject active management, however, and is rather active in managing each asset class, with approximately 85% of total assets being actively managed. Excess returns to date have led to the soundness and stability of its pension finances.
The risk and return of its overall portfolio is largely determined by a proportion of equities. When formulating its policy asset mix, PFA first determines the ratio of equities and then allocates bonds to the remainder. Alternative investments are also positioned as alternatives to either equities or bonds, and are invested as part of active management to diversify alpha sources.
Currently, PFA manages two different portfolios: "Basic Pension and Other" assets and the “Total Corporate Pension” plan.
The “Basic Pension and Other” portfolio includes both the substitutional portion (substitute part of public pension fund) and the additional portion that was instituted with the inception of the Association in 1967. Total assets were approximately JPY 12 trillion at the end of March 2022 (FY2021). Policy asset mix is a two-asset portfolio consisting of domestic and foreign bonds and domestic and foreign stocks, managed dynamically with the base value fluctuating with the funded level. As they are currently in a very sound financial situation and the reserve level is 124%, the ratio of domestic and foreign bonds to domestic and foreign stocks is 6:4, which is its standard.
PFA also makes full use of in-house management to ensure efficient asset management. PFA manages all in-house operations permitted by law, including domestic and foreign bonds, foreign exchange management (foreign exchange overlay), and passive management of domestic stocks, which account for about 48% of its portfolio.
The "Total Corporate Pension” plan is a portfolio of approximately JPY 500 billion consisting solely of the additional portion, which was launched in October 2005. Its average assumed interest rate is relatively low at 1.9%, so the portfolio is managed with a low-risk policy asset mix of 80% bonds and 20% global equities. Given the portfolio’s bond-centric profile, the percentage of in-house management has been increased to 57% in order to further improve investment efficiency under low interest rates.
PFA Portfolio Overview
Roles Divided by In-house and Outsourced
PFA’s equity group includes 8 members and its bond/currency/fund group includes 7. Each group is responsible for in-house investment management as well as management and evaluation of outsourced asset managers. All passive domestic equity investments are managed in-house, while active domestic equity and all foreign equity investments are outsourced to external asset management companies. All domestic and foreign bonds are actively managed, and approximately 70% of these are managed in-house. The solid performance (risk-adjusted excess return) of its in-house management allows PFA to outsource to more risk-tolerant external asset managers, to create a well-defined and efficient portfolio.
PFA invests in private equity (PE) as an alternative to foreign equities. As an alternative to domestic bonds, it invests in hedge funds and in real estate/infrastructure/private debt for long-term income gains, aiming to complement yields in a low-interest-rate environment. Alternative investments total slightly under JPY 2 trillion, accounting for about 15-18% of PFA's total assets.
The Association began investing in PE in the fall of 2002 before other alternative investments to diversify its assets by investing in a fund of funds. Later, PFA shifted its emphasis to single-fund investments by setting up separate accounts with gatekeepers with a proven track record worldwide. Today, PFA also invests in co-investments and secondaries.
While building its portfolio, PFA also experienced the global financial crisis. At the time, some major overseas pension funds were reducing new investments, but the Association continued to make new investments from a long-term perspective and amassed a high-quality portfolio with minimal vintage distortions that is now reaping great rewards.
PFA began investing in hedge funds in the fall of 2007. It now employs several investment advisory firms who have built a well-diversified portfolio of carefully selected single funds in dedicated separate accounts and have achieved good results.
PFA has been investing in real estate for some time, but in 2009 under a new structure, began to enlarge its portfolio. Currently, it invests only in domestic properties.
Regarding infrastructure, PFA has been investing since 2011 and mainly invests in diversified funds now.
Since 2016, PFA has invested in funds that provide stable cash flow, such as direct lending, under the "stable income investment" framework. Since real estate, infrastructure, and stable income are only alternatives to domestic bonds for the purpose of obtaining stable cash flows over the long term, PFA invests while comprehensively managing risks.
Performance to Date
Since FY1996, when PFA was exempted from the "5-3-3-2 regulation*” and could determine asset allocation based on their own responsibility and judgment, performance of the Basic Pension and Other portfolio has been 4.64% per annum until FY2021. The performance is 0.84% higher than the average of 3.79% for Employees' Pension Insurance (public pension), the basis for assessing substituted liabilities. The portfolio is managed mainly through active management, aiming to achieve excess returns. Over the past 26 years, PFA has achieved a cumulative excess return of 55.9% over the composite benchmark, or an average annualized return of 0.74%. PFA has achieved excess returns in 20 of the past 26 fiscal years, a high rate of 77%.
Although an excess return of 0.74% per year may seem low at first glance, when converted into an accumulated amount, the value-added amount is more than JPY 2.7 trillion even after subtracting management fees and other costs during this period. This is more than the pension plan's financial surplus of JPY 2.2 trillion.
* 5-3-3-2 regulation: Safe assets: 50% or more, equities: up to 30%, foreign currency dominated assets: up to 30%, and real estate: up to 20%
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