Japan’s corporate pension funds have undergone drastic changes in the last two decades. Around the globe, monetary easing in response to financial crises and the coronavirus pandemic has caused Interest rates to plunge. The Employees’ Pension Fund, the foundation of Japanese corporate pensions, has been effectively dismantled amid fraudulent schemes that took advantage of the changing market environment and deteriorating pension finances. Takashi Kisu, Senior Consultant for Fiduciary Management at Nomura Securities, analyses how pension funds have diversified and advanced their investment portfolios.
This following is an edited translation of an article originally published in AL-IN vol. 59, March 2021. The magazine (https://investmentjapan.jp/guide/2700/) marks its 15th anniversary with a series focusing on changes in asset management among Japanese corporate pension funds during that time.

Asset classes and management methods diversified, as did investment risks

CHART: Risk-Return Transition by Target Assets

Source: Nomura Securities

The range of assets held by Japanese corporate pension funds has expanded significantly over the past 15 years or so.  The chart above plots the risk-return level for each asset class and investment method every five years since 2005.  There are far more red dots (2016-2020) than blue dots (2001-2005).  The number of dots has nearly doubled from 35 in 2001-2005 to 64 in 2016-2020.

Many of the basic assets Japanese corporate pensions invest in today have been fairly common overseas for the last 15 years.  But these assets were rarely embraced by Japanese corporate pensions during the same period because there was little need.

Since then, many new assets and management methods have been introduced to Japan, driven by three principal needs: controlling risk, coping with low interest rates, and streamlining and outsourcing management (necessitated by the first two).  Containing risk dictated adopting a certain minimum of diversification and quality strategies for stocks.  To avoid risk on listed stock markets, funds embraced smart beta indexes, factor investments, and private assets.  Stock market volatility and accounting changes to immediately recognize actuarial gains and losses in pensions also drove change.  Low interest drove pensions to replace flagging income from public market interest rates and spreads through a variety of credit investments and private assets.  The expansion into new asset classes and management techniques, such as diversified growth and multi-credit and private multi-income strategies, has made managing pension fund portfolios more complicated.  As monitoring and switching strategies/managers have become more complex, pension funds have increasingly turned to outsourcing some aspects of management.

Portfolio frameworks become more sophisticated and diversified

Along with diversification of asset classes and investment methods, portfolio frameworks of corporate pension funds have also become more diverse.  In the past, most funds categorized assets by asset class.  Recently, some pension funds have adopted a dichotomous portfolio approach: dividing assets into those that pursue income and those that respond to liabilities, an approach that divides assets by risk factors; or a core-satellite approach, which divides assets into a core portion and a satellite portion that introduces highly unique strategies.

Meanwhile, some Japanese corporate pensions have established an “alternative quota”, something rarely seen among major overseas pension funds.  The term “alternatives” is broad and can include assets with any number of characteristics.  If such investments are not clearly identified or categorized, they might render risk control inadequate or escape governance altogether.  As pensions increase allocations of alternative assets, they should also review their portfolio frameworks.

The market environment continues to be one in which returns have dried up and risk taking is not rewarded.  However, in Nomura’s client base (excluding public mutual aid pensions), nearly half of corporate pension funds ended the fiscal year 2019 with positive returns, even after being hit by the market turmoil in January-March caused by the Corona pandemic.  Over the past 15 years, especially since the financial crisis of 2008, corporate pensions have gained valuable knowledge and experience, which may have led to last fiscal year’s positive results.  It is true that the level of target returns has been decreasing, but stable investment management that avoids excessive risks without sacrificing returns is bearing some fruit.


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