Alternative Investments: Mitigating Exposure to Stock Volatility

Our current fund makeup includes: domestic stocks (8%), foreign stocks (12%), domestics bonds (10%), hedged foreign bonds (25%), alternative assets (10%), multi-assets (10%), and life insurance general accounts (25%), with an expected rate of return of 2.5% and an operational target of 2.95%.

Until the early 2000's, domestic stocks made up 60% of the portfolio, but the stock ratios were reduced in conjunction with the timing of re-nationalization of a portion of the fund and changes in the expected rate of return. In times of extreme market movement, as we experienced during the Lehman Brothers bankruptcy, taking care not to exacerbate financial conditions is paramount for both the parent company and the fund.

Beginning in 2017, we instituted a two-year dynamic hedge for domestic and foreign stocks until we transitioned to the new portfolio following the 5-year actuarial review required by the law. We have set a yearly floor of -12.5%, limiting domestic and foreign stock losses to -2.5%, containing overall losses to around -3%, even if losses in other areas occur.

Alternative asset investments were limited initially to hedge funds (HF); however, we currently employ 14 strategies to diversify investment across four categories of insurance, real estate and infrastructure, and private equity (PE) in addition to HF. Insurance and real estate / infrastructure are expected to yield stable returns over time. Through PE, which adopts domestic PE funds and direct lending, we anticipate solid yields and a revitalization of the Japanese economy.

Among alternative assets, domestic private REITs provide the most stable returns. However, given Japan's shrinking population, we are concerned for the mid- to long-term that investors will abandon the Japanese real estate market in favor of foreign markets such as the USA, where the likelihood of falling demand is low.

We intend to meet the future by maintaining our ratio of alternative assets while employing new strategies and working for a fine-grained distribution. If the current ultra-low interest rate environment continues over the long term, we may well increase our alternative asset allocation ratio. Meanwhile, by employing a variety of strategies now, we position ourselves to respond swiftly to market conditions by expanding target assets when required. Our current portfolio composition of forty-four different products requires significant amount of time for quarterly operational meetings. At any rate, we recommend maintaining distribution of alternative assets across the four investment fields and steadily building returns.

We adopted four investment strategies in our previous review of the fund portfolio. While it is difficult to timely adjust asset distribution in response to market fluctuations, we are confident the multi-asset strategy will act as a portfolio hedge. Despite several short-term market drops since the implementation (e.g., China Shock), we have not yet faced a test of the multi-asset strategy comparable to the Lehman crisis. However, during the global stock market decline of January-March 2016 brought on by a steep drop in crude oil prices, the multi-asset bracket yielded positive returns while the fund as a whole suffered a loss. One weakness of the strategy was revealed, however, in that negative returns continued past the short-term drop and the market's subsequent sharp rally.

While we would prefer stronger returns, we are pleased with the fund's robust performance against drops in the stock market and we are satisfied it has met our expectations for risk management. We will continue to introduce new strategies to pursue profit and risk management while maintaining the successful multi-asset approach.