The Bank of Japan’s unprecedented monetary easing will fail in its goal of spurring 2 percent inflation, according to Takahiro Mitani, president of the fund that manages the world’s largest pool of pension savings.
While Japan is making progress toward ending deflation, consumer-price gains will probably stay between 0.1 percent and 1 percent, said Mitani, the head of the 124 trillion yen ($1.21 trillion) Government Pension Investment Fund (GPIF). The fund may revise asset allocations in as little as a year after a government-appointed panel recommended a review of domestic bond holdings, he said.
“A 1 percent inflation rate may be possible, but that’s different to the Bank of Japan target,” Mitani said in an interview at GPIF’s Tokyo headquarters today. “We haven’t seen real demand to pull prices up yet. Whether inflation will be stable is questionable.”
Mitani’s comments on inflation pit him against Takatoshi Ito, an academic handpicked by Prime Minister Shinzo Abe to head a panel advising lawmakers on pension allocations. Ito last month expressed faith in the Bank of Japan (BOJ) reaching its 2 percent target for price increases and said GPIF needs to hold investments that can provide higher returns as retirement payouts for the world’s oldest population rise.
Japan’s Topix index of stocks surged 62 percent in the 12 months through Sept. 30 for the biggest gain among global developed markets and the measure’s steepest rally in four decades. Domestic sovereign bonds handed investors a 1.8 percent return, an index compiled by Bloomberg shows. GPIF’s assets swelled by 15 percent in the same period, according to its financial statements.
GPIF’s website states its portfolio allocations are scheduled to remain unchanged until March 31, 2015. While Ito’s advisory group overstated the risks from owning local bonds, the fund will need to reduce its holdings at some point, said Mitani, a former executive director at the BOJ, who has headed GPIF since 2010. The nation’s stock market isn’t in a bubble, he said.
“Some changes can be done in about a year,” Mitani said. “We were already considering new investments,” such as alternative assets, he said.
GPIF owned 71.9 trillion yen of domestic bonds as of Sept. 30, with the investment making up 58 percent of its assets, according to its quarterly report.
Yields of 0.63 percent on benchmark Japanese sovereign 10- year debt, the lowest in the world, mean investors may face losses if the BOJ succeeds in its goal of spurring 2 percent inflation in about two years.
Japanese stocks pared losses on Mitani’s remarks, which imply the central bank may have to ease policy further and that GPIF may switch money from bonds into equities, according to Gavin Parry, managing director of Hong Kong-based brokerage Parry International Trading Ltd. The Topix pared declines to as little as 1.1 percent from 1.9 percent before the comments. The gauge closed 1.7 percent lower at 1,240.99.
The BOJ, led by Haruhiko Kuroda, is buying more than 7 trillion yen of bonds a month and has signaled a willingness to add more cash to the economy to reach the inflation target. Monetary easing, fiscal stimulus, and reforms to boost corporate earnings make up Abe’s three-pronged growth strategy known as Abenomics.
The nation’s consumer prices, excluding fresh food—the BOJ’s gauge for its target—increased 0.9 percent in October from a year earlier, government figures showed Nov. 29. A gauge of prices that also excludes energy rose 0.3 percent.
It’s been 22 years since annual inflation in Japan exceeded 2 percent, according to data compiled by Bloomberg. In the last five years of the 1980s, when Japan’s gross domestic product climbed from $1.3 trillion to $3 trillion and the Nikkei 225 Stock Average peaked at almost 39,000, the monthly readings for consumer price gains averaged 1.2 percent, the data show. The Nikkei 225 closed today at 15,407.94.
“It’s difficult to say whether we are really exiting deflation,” Mitani said. “Consumer prices are starting to rise, but a large reason for that is based on the weakening yen and rising energy prices. We can’t say that looking at recent results, we have really exited deflation.”
GPIF is under pressure to cover payouts as more Japanese baby boomers born in the wake of World War II turn 65 years old and become eligible for pensions. The government spent 52.2 trillion yen on pensions in the fiscal year ended March 31, 2012, a 1.1 trillion yen increase on the previous year, according to figures published by the health ministry.
Pension funds should assess investment risk assuming a 2 percent inflation rate, Ito told reporters after the release of the government advisory panel’s report last month.
“The environment is changing now,” said Ito, who is the dean of the Graduate School of Public Policy at the University of Tokyo. “All the panel’s experts share an awareness that it’s dangerous to keep on shaping the fund’s portfolio based on the risk and return assumptions that have been used to date.”
GPIF and other public pension funds should consider investing more in overseas assets, private equity, commodities, infrastructure, and real-estate investment trusts, the panel said. GPIF needs more independence from the Ministry of Health, Labor and Welfare, which currently oversees its investments, according to the report.
Japanese Economy Minister Akira Amari said on Nov. 20 he will work toward realizing the group’s proposals, while adding Nov. 22 that any changes in the management of GPIF will depend on whether Japan has deflation or inflation.
GPIF is discussing whether to use the JPX-Nikkei Index 400 as a benchmark for Japanese equity investments, as recommended by the report, Mitani said. The fund is also considering investing in inflation-linked bonds to protect against rising prices, while monitoring whether the market is large enough to avoid being distorted by GPIF’s potential buying, he said.
As GPIF invests more abroad, the Japanese currency may drop to 108 per dollar in the coming year, Eisuke Sakakibara, a former Ministry of Finance official known as “Mr. Yen” for his efforts to influence exchange rates in the late 1990s, said on Dec. 2. The fund should boost foreign holdings to as much as 35 percent from 23 percent, according to Sakakibara.
The yen touched a six-month low of 103.38 per dollar this week. It has plunged 19 percent over the past year, the worst performance among 10 developed-market currencies tracked by the Bloomberg Correlation Weighted Indexes.
Returns for Japan’s biggest pension funds were the lowest among 11 countries between 2007 and 2012 in local currency terms, according to a Towers Watson & Co. report that tracks the world’s 20 largest pools of retirement cash. Japanese funds shrank 1.2 percent during the period, compared with a 0.9 percent increase in the U.S. and 16.5 percent growth in China, according to the report.
GPIF announced in June a cut to its target holdings for domestic bonds to 60 percent from 67 percent as part of the first changes to its core portfolio since its inception in its current form in 2006. The proportion of foreign and local shares was changed to 12 percent each, from 9 percent and 11 percent respectively. The fund also raised its target for foreign bonds to 11 percent from 8 percent.
The California Public Employees’ Retirement System (Calpers) has a 50 percent target allocation for public equity holdings, compared with 17 percent for income investments, according to its website. Calpers is the largest public pension fund in the U.S. with $260.9 billion in assets as of Aug. 31.
GPIF’s returns trailed its three global peers in five of the past nine fiscal years, according to the fund’s website. The Japanese fund compared its returns against Calpers, Canada Pension Plan Investment Board, and Norway’s Government Pension Fund Global. The only year GPIF’s performance beat all three peers was in 2008 amid the global financial crisis, when shares around the world tumbled.
“Our investment was based in a deflationary environment domestically, so you can’t simply compare it to those abroad,” Mitani said. “Considering the price declines and wage declines we had, we don’t see our investments results as being especially lower than the ones abroad.”
GPIF earned a 2.7 percent return in the three months through September, boosting assets to a record, the fund said Nov. 29. Domestic stock holdings returned 6.1 percent, while local bonds yielded 1.2 percent. Foreign debt gained 1.6 percent and overseas stocks added 7.1 percent.
“They need to take on more risk to increase their returns,” said Masaru Hamasaki, a senior strategist at Tokyo-based Sumitomo Mitsui Asset Management Co., which oversees the equivalent of $110 billion. “Like their global peers, such as Calpers in the U.S. and pension funds in the U.K., they should increase their equity allocations. They need to ride the global economic growth wave.”