The thing about being a pension fund in a world where returns on risk free assets are at best an inflation adjusted zero and at worst guarantee a loss when held to maturity is that you’re effectively forced to go out and take bigger risks if you want to hit your targets. In the US, public sector pension funds cling to the fantasy that they can return 7-8% while still keeping risks manageable while a lower discount rate attributable to ZIRP and NIRP has caused the present value of eurozone defined benefit plan liabilities to soar. In short, the “lower for longer” rates regime can be tough for large pension funds to navigate as the whole enterprise becomes an impossible balancing act between achieving an acceptable rate of return and managing risk.
Earlier this month we took a look at the Q3 numbers for The Government Pension Fund of Norway (the SWF) and the picture was not pretty. In what amounted to the worst quarter in four years, the fund lost 16% on EM equity bets. All told, the SWF lost 5% in Q3.
Back in March, we noted that Japan's $1.1 trillion Government Pension Investment Fund - the largest pension fund in the world - was a big seller of JGBs in Q4 as the fund moved aggressively into stocks on the heels of an October 2014 directive from PM Shinzo Abe who encouraged more risk taking. As a result, GPIF cut its targeted holdings of government bonds and doubled its target for stocks. Here's what we said earlier this year:
Pension funds the world over are increasingly adopting the same behavior as other investors in a world characterized by artificially suppressed yields: they’re shifting to riskier assets. In the case of US public sector pension funds this is a necessity because assumptions about investment rates dictate the discount rate used to calculate the present value of liabilities and so as soon as you admit you can’t make 8% when risk-free assets are yielding less than 2% in the US and close to or less than 0% in other locales, you effectively become even more underfunded than you already were. The solution is to take more risks in order to justify return expectations and in the US the percentage of funds' capital dedicated to equities has risen from under 30% in the mid-eighties to as high as 60% more recently while the fixed income allocation has steadily fallen.
As you might expect, Japanese public pension plans are also feeling the heat as the BOJ has driven yields on JGBs into the ground by planning to monetize the entirety of gross issuance. The result has been a truly epic shift out of domestic government bonds. As Bloomberg reports, Japan’s Government Pension Investment Fund sold nearly $50 billion in JGBs in Q4, opting instead to chase after higher returns in the stock market.
Now clearly, promoting risk-taking with assets earmarked for public sector employees’ retirement is a strategy that has the potential to go south in a hurry if the market moves against you and because you can't designate your equity portfolio as "held to maturity," you run the risk of incurring substantial losses.
Well, maybe Abe just assumed that perpetual Kuroda plunge protection would ensure that no matter what, equities wouldn't swoon, or perhaps everyone in Japan still believed that an Abenomics-led economic renaissance was just around the corner and so stocks were the place to be, but whatever the case, Japanese public pension funds' dramatic shift into equities looks to have cost them dearly in Q3 as GPIF just turned in its worst quarter since 2008.
"The 135.1 trillion yen ($1.1 trillion) Government Pension Investment Fund lost 5.6 percent last quarter as the value of its holdings declined by 7.9 trillion yen," Bloomberg reports, adding that "the fund lost 8 trillion yen on its domestic and foreign equities and 241 billion yen on overseas debt."
Bloomberg goes on to note that "the loss was GPIF’s first since doubling its allocation to stocks and reducing debt last October, and highlights the risk of sharp short-term losses that come with the fund’s more aggressive investment style." In fact, if you strip out a portfolio of government bonds tied to fiscal stimulus spending, "the drop was the fund’s third-worst on record, exceeded only by declines in the depths of the 2008 global financial crisis and the aftermath of the Sept. 11, 2001 terror attacks."
Here's a look at the trends in asset allocation via Nomura:
The fund's share of domestic bonds sat at 38.95% at the end of September, up from 37.95% in Q2 while the share of domestic equities fell to 21.35% from 23.39%. But that just reflects the valuation effect. As Nomura points out, it's likely that GPIF bought equities at a higher rate during Q3 (fiscal Q2) than during Q2.
For the punchline we go to Hiroyuki Mitsuishi, a councilor at GPIF, who says that when you really think about it, doubling the allocation to stocks when equities are at all-time, Kuroda-inflated highs is probably the best way to safeguard retirees' income - you know, except for all of the volatility:
“Compared to our past portfolio, swings in returns have become wider. But in the long-term view, we see there’s less risk of failing to meet pension payouts with the new portfolio.”
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