Japan pensions dismiss fears over negative rates

Japanese corporate pension funds are in decent shape to cope with an environment of negative interest rates amid misperceptions about the industry, heard an AsianInvestor forum.

Even a crash similar to the one that followed the collapse of Lehman Brothers in September 2008 would still see the industry’s assets-to-liabilities ratio remain more than covered, according to case studies.

Speaking at the Japan Institutional Investment Forum in Tokyo last week, pension fund executives said they were focusing more on reducing costs than factoring in downside risk protection. But some also acknowledged that returns on Japanese government bonds (JGBs) were frighteningly low and raised questions as to whether it was even appropriate to enter such a negative investment from a fiduciary standpoint. 

“Personally I would find it difficult to explain such a move [investing in JGBs with a negative rate], so in many pension funds there will gradually be a shift to alternative investments,” said Shunichi Kubo, president of Nikkei Pension Fund. He was speaking about whether Japanese pension funds could survive an age of negative interest rates, following the central bank introducing interest rates of -0.1% from February 16.

Kubo said the media had focused on banks and insurers when writing about the impact of negative rates and wondered why corporate pension funds never figured in this discussion.

He proceeded to set out the industry’s position, saying the asset-liability ratio stood at 1.25x – or 125% – meaning it is 25% over-funded. A Nikkei Pension Fund working group forecasts this will fall to 1.19x by the end of March.

Kubo presented two test cases: one where equity yield was 5% and another where it was 2%, both with bond yields ranging from 0% to -2%. In the scenario where the equity yield is 5% and the bond yield 0%, it would take 13 years for a fund’s reserves to be fully used up, and six years if the bond yield were -2%. With 2% yield from equity and 0% from bonds, it would take eight years to exhaust the reserves, and four years if the bond yield were -2%.

“So even if it [negative rates] continues for several years, the assets will continue to be above the liabilities,” Kubo observed. He added that even if the Nikkei 225 stock index sank 62% from its high of 20,868 points on June 24 last year to 8,000 points (it fell 62% after the Lehman collapse), the asset-liability ratio would still remain above 1.

“This may be better than you might have expected,” Kubo said, noting how the starting point for rates had been very low to start with. “So in terms of yield and return, there is no large impact [from negative rates].”

In an industry roundtable on whether investing in bonds was still a valid approach for meeting liabilities, Kubo said JGBs and other bonds served as a portfolio stabiliser, given their negative correlation with risk assets. Nevertheless, he agreed that JGBs' attractiveness was declining.

Certainly, active managers for telecoms group KDDI’s pension fund have not invested in JGBs for three or four years but into corporate credit, as the fund had been seeking higher returns, said Tomoko Igarashi, senior investment officer. “For corporate bonds we have not gone into negative territory yet, so the impact [of negative rates] has been limited,” she added. She said KDDI could enjoy return opportunities through passive investment into JGBs based on its diversification policy.

While the fund’s obligations have increased, she added, it signed up to International Financial Reporting Standards (IFRS) last year and has not had to write off under-water assets. She expressed surprise that just 100 of 1,800 companies listed on the Tokyo Stock Exchange had adopted IFRS in their accounting.

Asked how the rates environment had affected KDDI’s fund from an asset management perspective, Igarashi said it had returned an average of 6% annually for the past 13 years, with equities and foreign exchange contributing the lion’s share.

When Igarashi started in the pension department seven years ago, she said, the fund was largely exposed to active investments, with passive and cash at less than 20%. Now that the fund’s returns have fallen, she said it could not afford to incur such costs and so had increased its passive allocation and its cash ratio, while targeting alpha from higher-risk investments in a 'barbell' portfolio approach.

But she is wary about alternative assets and absolute return. “We should not consider being attracted to those so easily. A lot of institutions tend to go for what is trendy and then get into trouble for doing that,” Igarashi said.

Meanwhile, JGBs represent about 55% of Nikkei Pension Fund’s total assets, with the other 45% accounted for by assets hedged against foreign-currency risk including US bank loans, emerging-market fixed income and high-yield bonds.

In any case, pension plans have to take into account their sponsors’ requirements, which often oblige them to invest in bonds, noted Ken Nagata, who works in the treasury department at IBM Japan and helps manage its pension.

On the question of managing downside risk, it still does not appear to be a high priority for retirement funds in Japan.

Kubo said he had been involved in the pensions industry for 14 years and that it had never seriously tackled downside risk. He suggested funds should “just persevere and work at reducing costs”, while suggesting they could look to set market targets to instigate a downside-risk strategy.