Guest Post: The Plot Thickens: How Will Japan's Largest Pension Fund Find Room To Maneuver?

Tyler Durden's picture

Submitted by Taylor Conant of Economic Policy Journal

The Plot Thickens: How Will Japan's Largest Pension Fund Find Room To Maneuver?

The WSJ is out with a short piece about new rumblings coming from Japan's $1.43T public pension fund, Japan's Public Pension Weighs New Investments. If I may be so bold as to impersonate the Japan deflation-blogger Mish
for a moment, let's take a look at a few of the dynamics at play as
reported by the WSJ. I'll provide some commentary along the way:

public pension fund—the world's largest with assets totaling 123
trillion yen ($1.43 trillion)—is weighing the controversial idea of
investing in emerging-market economies as a way to gain higher returns
as it faces a tsunami of payout obligations over the next several years.

conservative Government Pension Investment Fund, which alone is larger
than India's economy, has a staggering 67.5% of its assets tied up in
low-yielding domestic bonds. The fund plans to sell off a record four
trillion yen in assets by the end of March 2011 to free up funds for
payouts to Japan's rapidly aging population. By the year 2055, 40% of
Japan's population is expected to be over the age of 65.

There's a lot to discuss but before I do I want to clarify an error I believe the journalists who wrote this piece made.

comparison between the size of the GPIF and the size of India's
"economy" is not a meaningful one because the GPIF is a "stock" while
the aspect of India's economy being referred to, GDP, is a "flow". At
$1.235T (2009 estimate,
Wiki), India's GDP is supposed to measure the total monetary value of
output of all goods and services for a particular period of time, in
this case one year. Meanwhile, GPIF's asset base is a static measurement
of current asset valuation. I'll avoid the bath tub analogy and instead
refer to public company financial accounting: GPIF's asset size is like
examining an entry on the asset side of a company's balance sheet;
India's economic "size" is like examining an income statement for the
revenue or earnings generated in the period in question.

other minor quibble-- the "2055" statistic is completely irrelevant to
telling this story because the GPIF is not going to last that long, at
least not in its present form and at its current levels of funding.

the fur out of the way, let's dig into the flesh of the matter. First
things first: the GPIF is another Ponzi-finance scheme, much like the US
Social Security Administration system. I think Takahiro Mitani,
president of the GPIF, explained the predicament all Ponzi-finance
schemes eventually find themselves in best in this recent WSJ interview:

Mr. Mitani: Baby boomers are now 60 years old or older, and have started receiving pension.
In the meantime, the number of people who pay a pension premium is
smaller. What's more, pension premium is determined by wage, which has
been on decline.
So, pension special account overseen by the
health ministry is having a tough time.… More outlay than income in the
pension system means that they need to tap into the reserve we have.
[emphasis added]

Long-term, the GPIF and SSA will always be
running up against a potential demographic problem like this, where the
amount promised to past generations of present retirees is greater than
the amount being contributed by present workers. Therefore, there will
come a time in every Ponzi-pension fund's life during which the managers
of the fund will be forced to go out on the risk curve in a search for
yield. And as luck would have it -- or rather, as generations of
inflationary central planning schemes would have it -- the very time
these demographic trends reach an apex, so, too, do long-running
financial trends on which the fund's internal rate of return projections
have been built. In other words, the perfect financial storm, a
"liquidity event" of colossal proportions, metaphorically and

Unfortunately for Mr. Mitani and his loyal
horde of investment management professionals (you did know that scams
like the GPIF also serve as lucrative
government-sponsored subsidies to investment banks like BlackRock,
Morgan Stanley and State Street, Mitsubishi UFJ Financial Group and
Mizhuo Financial Group
, didn't you?) there's more than just wind and
noise coming out of those storm clouds in the form of macro demographic
and economic trends, though they are all related in a way. Another
problem facing the GPIF is political and is tied up in the composition
of the GPIF's portfolio:

The GPIF holds the lion's share
of its assets in low-yielding Japanese government bonds. (The yield on
the 10-year JGB is currently a paltry 1.07%.) Roughly 67.5% of its
assets are parked in domestic bonds, including government and corporate
bonds; the rest are spread among Japanese stocks, overseas shares and
foreign bonds.

The GPIF is a Ponzi, wrapped in a Ponzi, inside an enigma. If you take a look at the investment results for the first quarter of fiscal 2010[PDF]
provided by the GPIF, you'll see that the "domestic bonds" portion is
split roughly 76% into "market investments" (JGBs of varying maturities)
and the remaining 24% into "FILP bonds".

FILP bonds, issued by
the Japanese Ministry of Finance's Fiscal Investment Loan Program, are
similar to agency debt and municipal/public works bonds floated by US
state and federal government agencies (think FRE/FNM, FHLB, New York MTA
bonds, DOT/highway bonds, public school and university bonds, etc.).
According to the Japanese MoF's own online resource page, which I
encourage you to click and skim-read in its entirety for yourself, FILP bonds can be issued to fund nearly anything
the Japanese government might deem worthy of funding, including
"housing construction, small and medium-sized businesses, roads,
railways and subways, airports, water and sewerage [sic], education,
medical care and social welfare, agriculture, forestry and fisheries,
industry and technological development, regional development" and let's
not forget "international cooperation."

Like I said, nearly
anything. And with Japan's bubble-fueled reputation for being a corrupt,
greasy-handed place to get business done, you can bet that at least one
of almost everything in Japan's economy (and other countries'
economies!) has been funded exactly this way. The FILP is like a giant
government-sponsored slush fund for amakudari, Japan's version of the "golden parachute" for its fascistic, entitled union bosses-cum-career public servants[PDF].

Back to the Ponzi within a Ponzi. One reason that Japan's central government has been able to issue so much debt ($10.55T and rising as of the end of June) without blowing yields sky-high is due to the phenomenon of captive finance, an ugly cousin of vendor financing,
of which government managed pension funds like GPIF are a facilitator.
It works like this: the Japanese government issues debt, the Japanese
worker is forced to contribute to a government pension fund such as
GPIF, and the GPIF buys the Japanese government's debt because it's
"safe". Hopefully you can see it now. The Japanese government must keep
rolling over debt into new debt just to stay afloat which is purchased
by the GPIF, while the GPIF must keep milking workers to pay off the
retirees. Ponzi within a Ponzi.

Something's gotta give. But
there's the rub-- it can't. According to the WSJ article, 67.5% of
GPIF's funds are committed to JGBs and FILP bonds (the allocation as of
the Q1 investment results[PDF]
linked to above was 68.14%) with the remaining portion divided up
approximately 9% international stocks, 8% international bonds and 11%
domestic stocks. It can't easily touch that 67.5% allocation without
experiencing stern consternation from Japanese politicians who see their
Ponzi-scheme unravelling before their very eyes.

That means the
search for yield will have to come from elsewhere in the portfolio, and
anywhere else it might come from means potential pain for the supplier.
Think the Nikkei can't go lower? Think the US Treasury has enough
problems? Think the S&P 500 has been beat up enough already? Think
again. Meanwhile, wherever the GPIF potentially re-places the funds
could see a nice little second-wind. Good-bye SPY, hello EWZ!

being facetious but hopefully my point is clear. Of course, where
government is concerned, "can't" doesn't always mean "won't":

its four-trillion-yen selloff this year, Mr. Mitani said: "We won't
only target [selling] domestic bonds. It could be [Japanese] stocks or
foreign-currency-denominated securities or stocks," depending on market

At the end of the day, Japanese politicians can
kick and scream but the GPIF has to meet its liquidity needs and one way
to do that is to suck it up and kick some JGBs and FILPs out the door.
Again, this is a problem and it will be chronic until it is terminal.
Pay attention those of you long JGBs.

John Vail, chief
global strategist at Nikko Asset Management, echoed that sentiment.
"They need to take on more risk. As a long-term investment, equities
will nearly always outperform JGBs," he said "Global equities are a wise
investment for the GPIF—especially with equities being so inexpensive."

Mitani said he is aware of such opinions, but his mandate is to invest
in "safe" assets with a long-term view. "In 2008 after the collapse of
Lehman, while we posted a negative result we were relatively better than
overseas pension funds thanks to our conservative, cautious stance. We
posted only single-digit [percentage] loss while others posted
double-digit loss," he says.

In the U.S., the California Public
Employees' Retirement System, known as Calpers, is the nation's largest
with assets of $200 billion. Calpers reported a 23% slump in the year
ended June 30, 2009, marking its worst year ever. Some of the biggest
hits were from private or alternative investments such as real estate.
Calpers has since begun pulling back on such exposure. In comparison,
the GPIF reported only a 7.6% slump in the fiscal year ended March 31,

That list bit about comparative slumps should clue you
in as to where the GPIF is going to want to go to first when it comes
to meeting liquidity needs. Why sell volatile equity securities and
potentially lock-in another loss when you can sell some ultra low-yield
JGBs and FILPs, perhaps even turning that ROI-frown, upside-down in the

A special thanks, by the way, to John Vail of Nikko
Asset Management, for providing some much-needed "useful idiot"
stock-jobber equity permabull nonsense encouraging the GPIF to go out on
the risk curve a bit more. Over the long-term, equities will
"nearly-always" outperform JGBs... except for the past 30 years (image pulled from Mish):

Dang, looks like the long-term can be very long, indeed.

Meanwhile, Mr. Mitani seems fairly confident that the Ponzi-scheme will be kept up a bit longer:

Mitani expects the 10-year JGB yield to mostly stay below 1.5% for the
next two to three years, though it may break above that point
temporarily. He added that he isn't too concerned about the risk that
JGB prices will plunge due to fears about increasing JGB supply,
creating a Greek-style fiscal crisis.

"If financial firms keep
receiving ample funds from [the Bank of Japan], if companies remain
reluctant to borrow, and if individuals keep savings at banks, there's
no choice but to purchase government bonds," Mr. Mitani said.

Maybe. Hayman Capital Advisors' Kyle Bass doesn't seem to think so. Either way, it's not a popularity contest. Just keep in mind that that's a lot
of "Ifs". The other thing to remember is that the GPIF may be the
biggest fund facing this kind of problem, but it is far from being the
only one, in Japan and around the world. As discussed above with the
Ponzi within the Ponzi, there are a lot of moving pieces in these deadly
contraptions and this type of intertwined financial structure has been
rigged, Rube Goldberg-style
(you're going to have to click the link and watch the 2min vid to the
end to see just how ironic a choice it was given the subject matter at
hand), across the world's pension and financial systems as well as

I know not when it will end, but I do know this-- when these things end, they don't end well.

More reading on the subject, in the event that the preceding was not enough:

  • interview with Takahiro Mitani, president of the GBIF
  • How does the Fiscal Investment and Loan Program work?, Ministry of Finance, Japan
  • Fiscal Investment and Loan Program (FILP) Plan: FY2009[PDF]
  • Explanation of monetary and fiscal policy of Japan, Wikipedia, referencing FILP as Japan's "second budget" (every country has one... or two... or four...)
  • Historical investment results for the GPIF (for trend-watcher aficionados)
  • Thematically-parallel article on the pension problem in the US, also posted today,, teaser to whet your appetite:
    of America's largest pension funds are sticking to expectations of fat
    returns on their investments even after a decade of paltry gains, which
    could leave U.S. retirement plans facing an even deeper funding hole and
    taxpayers on the hook for huge additional contributions.

    median expected investment return for more than 100 U.S. public pension
    plans surveyed by the National Association of State Retirement
    Administrators remains 8%, the same level as in 2001, the association

    The country's 15 biggest public pension systems have an
    average expected return of 7.8%, and only a handful recently have
    changed or are reconsidering those return assumptions, according to a
    survey of those funds by The Wall Street Journal.


    rosy expectations persist despite the fact that the Dow Jones
    Industrial Average is back near the 10000 level it first breached in
    1999. The 10-year Treasury note is yielding less than 3%, and inflation
    is running at only about 1%, making it tougher for plans to hit their
    return targets.

    Is this story starting to sound familiar or what?