As the world’s biggest pension manager moves closer to putting more money in risky assets, the ruling Liberal Democratic Party’s deputy policy chief says the fund needs to change its governance first.
Japan should submit a bill in the next parliamentary session to overhaul the structure of the 126.6 trillion yen ($1.2 trillion) Government Pension Investment Fund, Yasuhisa Shiozaki said in a speech at Bloomberg’s offices in Tokyo yesterday. With the fund working on a separate investment-strategy review, discussion is needed on whether it’s right to alter asset allocations before the law change, he said.
“We have to fix GPIF’s governance structure in the extraordinary session and then rework its portfolio,” said Shiozaki. “Governance reform is paramount and it’s important to get it done before the weightings get changed this fall.”
Policy makers seeking to add a board of directors and tougher oversight of GPIF’s investment decisions are running out of time to revamp the fund’s legal structure before it announces its asset review, expected in Japan’s autumn. The Topix index rose 12 percent from this year’s low on April 14 through yesterday amid speculation that GPIF will buy more local shares.
“The investment and governance reforms should go hand in hand, with governance coming first,” Shiozaki said.
Prime Minister Shinzo Abe’s growth policies, revised in June, urged GPIF to immediately alter its asset mix as the economy exits deflation, and strengthen the fund’s oversight.
LDP Plans
The LDP is working on a bill to establish a board of six or seven directors to oversee GPIF, Kozo Yamamoto, a party official in charge of preparing the policy, said in May. Changes may also include allowing direct investments in a broader range of assets, as well as the creation of risk and governance committees, Yamamoto said.
The overhaul of GPIF is likely to be successful because Abe’s government has a firm grip on power and can push changes through, Takatoshi Ito, who headed a group that advised lawmakers on public pensions last year, said in a panel discussion at yesterday’s Bloomberg event.
“The premise is the Abe regime will remain in power for the long term,” Ito said. “If it’s an administration that will be around for a long time, it’s harder for people to say no.”
Under the current system, GPIF President Takahiro Mitani and the health ministry have the final say on investment decisions and the fund is barred from buying stocks directly.
GPIF is already making changes that don’t require parliamentary approval, announcing plans this year to invest in infrastructure, adopt Japan’s stewardship code and hire new domestic stock managers. The fund has also won flexibility to pay higher salaries to attract investment staff.
Seven Samurai
“GPIF has less than 100 people, and it’s been said only seven of them are investment professionals, like the seven samurai,” Shiozaki said. “We really need to add experts.”
GPIF has started a serious review of its portfolio, Shigehito Aoki, an official at the fund, said at a briefing last month as it reported an 8.6 percent return in the year through March, buoyed by an equity rally in the first three quarters.
The Topix sank 0.8 percent to 1,254 as of 10:23 a.m. local time, its fifth day of declines. The measure plunged 7.6 percent in the first three months of this year, before rebounding 5 percent the following quarter.
“We want GPIF to diversify its investments,” Shiozaki said in an interview with Bloomberg after his speech. “We aren’t saying they should buy more stocks. They should decide what to buy themselves.”
Reducing RiskIt's obvious that GPIF's governance has to change as their asset allocation changes to take on more risk, which is what Soros has been urging them to do to prevent global deflation.
The fund isn’t holding the right assets to reduce its investment risk, especially as Japan’s inflation picks up, according to Shiozaki.
“They have too much domestic debt,” he said. “Their asset allocations have been off when you think of risk management.”
GPIF will pare domestic bonds to 40 percent of holdings and boost local stocks to 20 percent, according to the median estimate from a Bloomberg survey of analysts in May. That would require selling 19.5 trillion yen of debt and buying 4.5 trillion yen of equities, calculations by Bloomberg using the fund’s holdings at the end of March show.
“Is it OK for GPIF’s governance to stay the same when its asset allocations change?” Shiozaki said. “We have to think about that.”
And unlike Japan's private plans which are eying more risk in international stock and credit markets, GPIF is looking to invest more in domestic equities. Of course, this could change as the governance of the fund changes and investment managers supervised by a (hopefully) independent investment board look at where the best opportunities lie across public and private markets around the world.
In my opinion, GPIF should follow the same governance as the CPPIB and improve on it by being more transparent. For example, while CPPIB lists their private partners, it doesn't publish the net IRRs of the funds and the fees paid out to each fund (none of the large Canadian public pension funds do but some of the large U.S. funds like CalSTRS and CalPERS post performance figures).
What else? A few weeks ago, I had a very interesting conversation with Theodore Economou, the CEO and CIO of Cern's pension fund, a fund that thinks like a global macro fund. Theodore told me that the head of risk at Cern's pension fund reports directly to the board of directors, not the CEO. "This way the board is aware of the risks of each investment and they're responsible for accepting the risk."
I long argued for a separation of risk from investments at the board level and made that recommendation in my report to the Treasury Board of Canada when I reviewed the governance of the Public Service pension plan.
Amazingly, none of Canada's large public pension funds have the head of risk reporting directly to the board. Instead, they typically report directly to the CEO/CIO or the CFO, which ultimately engenders conflicts of interests. What do you think happens when the risk department is worried about risks of a certain investment? I can tell you exactly what happens, they shut up and bow their heads to the investment staff and rarely report their concerns to the board for fear of losing their job.
And if I remember correctly, Cern's head of risk is in charge of all risks, including operational risks. GPIF is a giant pension fund and with all that money comes a bunch of non-investment risks, like the risk of fraud and corruption.
Japan's pension funds are notorious for corruption. Back in December, an employee of Deutsche Bank‘s Japanese brokerage unit was arrested on suspicion of showering a local pension fund manager with expensive meals, golf outings and trips overseas in return for some 1 billion yen in investments.
Of course, that type of nonsense happens everywhere, not just in Japan. I recently discussed bribing pension fund managers, highlighting the case Fred Buenrostro, CalPERS' former CEO who took $200,000 in cash from Alfred Villalobos, a former CalPERS board member, in a paper bag and shoebox.
In reforming its governance, GPIF should take these risks very seriously by paying their staff properly and by implementing the tightest fraud checklists available. They should commission an independent operational risk report every two years by certified fraud examiners who can look into all aspects of vendor and external manager relationships.
GPIF should also commission an independent performance audit, above and beyond the standard financial audit by one of the big accounting firms, to make sure investment managers are taking proper risks relative to their benchmarks (see my comment on PSP's FY 2014 results).
I know, people reading my comments will roll their eyes, but I've seen too many shady things in my previous career at large public pension funds and I basically don't trust anyone. And I'm not impressed with the Auditor General of Canada and their flimsy special investigations which basically rubber stamp whatever the accountants approve. What a total disgrace!
I think GPIF has to incorporate world class governance by looking all over the world, not just in Canada, to gain a better understanding of who is doing a great job in each department of a pension fund. One governance model I really like a lot is that of Norway's Government Pension Fund, but there are other models worth researching.
Once again, if you have any comments or questions, you can post them below or feel free to reach me by email (LKolivakis@gmail.com). I ask that you support this blog by subscribing or donating via the PayPal buttons at the top right-hand side and don't forget to click on the ads on this blog (that's free for all you cheapskates who have yet to contribute a dime but keep reading me).
Below, Takeshi Fujimaki, who once advised billionaire investor George Soros and holds a seat in Japan’s upper house of parliament, talks about the government's economic policies, the yen and the Government Pension Investment Fund (December, 2013).
Fujimaki thinks GPIF's foreign assets should exceed 50%. He might be right but they better get the governance right first or risk sustaining heavy losses in their giant pension fund.