Traders closely studyhow pensions funds, controlling$73 trillion, planto spend their firepower. But lately,the industry’s biggest whales are creating outsized dislocation and trepidation in global currency and bond markets.The excessive market scrutiny and speculation that big pension funds are attracting now demands a rethink in portfolio management.
An unusual meeting at Japan’s Government Pension Investment Fund, or GPIF, in late August has sparked speculation that the $2 trillion manager will increase its current 25% allocation target for domestic bonds. Days later, Norway’s sovereign wealth manager proposed an overhaul of its government bond portfolio, potentially offloading US Treasuries but increasingholdings of Japanese debtbecause of a technical change in how the fund measures the market.
These separate but related developments have propelled a strong rally in the yen, creating a tricky situation for the Bank of Japan. Anything short of a hawkish hike at its meeting next week can be met with rapid selloffs in the country’s currency and sovereign credit.
It doesn’t have to be this way.When it comes to being on the frontier of investing, GPIF can certainly learnfrom America’slargest public pension program, the California Public Employees’ Retirement System, or CalPERS. In July, the $637 billion fund formally adopted the so-called “total-portfolio approach,” or TPA, making it the first US pension fundto do so.
By going with TPA, CalPERShas ditched rigid allocation bands to stocks, bonds and alternative investments. Instead, the fund will pursue a bottom-up approach to achieve the best returns possible. CalPERSnotched a handsome 14.8% in the fiscal year ending June. But with a funding ratio of 85%, the system still doesn’t have enough assets to meet the future liabilities to more than2million members.
Meanwhile, GPIF — and most pension funds — still adhereto the traditional strategic asset allocation approach. The investment arm of Japan’s public pension program, with about 67 million enrollments,splits its portfolio into four equal-weight asset classes, allowing 5% to 6% deviation limits for each.
As a result, mechanical rebalancing can occur often. During the pastquarter,a strong stock rally forced the fundto offload its equity holdings and buy bonds just to maintain its own mandate. This reshuffling, which dented returns, could have been avoided under the total-portfolio approach. Instead of obsessing over hitting fixed asset-class-weight targets, TPA asks if an investment improves the overall risk-return profile.
CalPERSswitched to TPA because Chief Investment Officer Stephen Gilmore believes it can generate super returns. Over the last decade, adopters,including Australia’s Future Fund and the New Zealand Superannuation Fund,notched up75 basis points inannualized excessive returns over the traditional approach, according to consulting firm Global SWF.
But more than higher capital gains, this year’s sharp market moves — driven in part by the global AI trade — are raising credibility concerns for managers whopigeonhole themselves into allocation limits. This problem is acutelypronounced with South Korea’s $1trillion National Pension Service, or NPS, which bent its own rules in pursuit of better returns.
In late May, the Koreanfund lifted its domestic equity target for the year to 20.8% from 14.9%to justify not selling its Kospi holdings. While having done well riding the year’s hotteststock rally, the NPS has to confront criticismas to why it was abandoning its long-term vision of global diversification, and whether its decision not to sell local shares exacerbated this summer’s retail frenzy and market volatility. The one big player that was supposed to tame the market was absent.
Under the total-portfolio approach,a pension fundwouldn’t have to make thesekinds of very publicand possibly embarrassingchangesto its investment mandates. Itallows money managers to focus on what they’resupposed to do — adding value for retirees — and nothing else.
By assigning equal weights to equities and bonds, as well as domestic and foreign assets, GPIF is acknowledging the diversification benefits of fixed income and globalization. But these assumptions are being challenged. The long-honored rule of holding a mixture of stocks and bonds failed to safeguard nest eggs during a global equities rout in 2022. With fiscal deficits on the rise, G10countries’government bond markets are more interdependent, as evidenced by US Treasury Secretary Scott Bessent’sattempts tobeef up the yen.
With the investing universe in flux, TPA offers managers the flexibility to explore new optimal portfolios. The traditional approach, on the other hand, is coming across as clumsy and outdated. Japanese Health MinisterKenichiro Ueno, who oversees the fund, said that GPIF is still considering whether a review of its asset allocation is needed.Should itdecide to tweak its targets, markets will ask if it’s an investment decisionor a political one. It’s much harderto argue against TPA’srelentless focus on the overall return.
Granted, for TPA to work, collaboration is essential. Organizations needto break down thesilo mentality across investment teams. Whether GPIF will adopt this modern experiment ultimately comesdown to mindset. Is Japan’s biggest pension fund willing to change?
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This column reflects the personal views of the author and does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. A former investment banker, she was a markets reporter for Barron’s. She is a CFA charterholder.
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