Transition managers raise prospect of Japan reallocations

Given the sell-off of Japanese stocks following last Friday’s devastating earthquake and tsunami, institutional investors are likely to reallocate portfolios on a longer-term basis, suggest transition managers. But some don’t see clients making major long-term shifts away from Japanese assets.

“Investors will be reassessing their risk-reward profile in Japan and looking at what their response will be, and that may trigger transitions,” says David Gagnon, Asia-Pacific head of transition management at BlackRock in Hong Kong.

Japan’s Nikkei 225 index slumped 16.3% over the first two days of this week from last Friday's close, its worst two-day losing streak since the global equity crash of October 1987. It subsequently rallied 5.7% on Wednesday, but then fell by 1.4% yesterday to close at 8,962.

The disaster is likely to be an earlier trigger for equity portfolio transitions than fixed-income ones, suggests Gagnon. “Changes in equity exposure are going to be implemented quickly,” he adds, “because most pension funds have capital preservation as a top priority.”

That said, on the fixed-income side, sovereign exposure through Japanese government bonds (JGBs) is significantly affected by current events, adds Gagnon – for example, as a result of lower tax receipts from reduced economic activity and, consequently, higher overall indebtedness levels. These developments can ultimately translate into changed investor appetite for JGB holdings.

The effect of the events on exporters impacts the credit-risk exposure of corporate debt investors, he says. The scale of the disaster will force investors to reassess the medium- to long-term implications of Japanese corporate debt, and changes in portfolio composition are likely to occur.

Transitions will remain tricky but feasible, given the central bank’s actions to support liquidity in the capital markets, argues Gagnon.

“There is significant liquidity in the market in terms of current transitions,” he says. “The Bank of Japan has taken good initial measures to flood the market with liquidity, so while it is very volatile, liquidity is still there for those who need to execute transitions as further developments occur.”

Others take a similar view on the short-term implications for portfolio restructuring. There is unlikely to be an immediate need for transition-management capabilities, says Richard Surrency, Asia-Pacific head of transition management at Morgan Stanley in Singapore.

However, he argues that transition activity is likely to rise in the long-term, as formal asset-allocation decisions are reviewed against the impact of the crisis. “Given the extent of the impact,” adds Surrency, “we see transition clients bringing forward allocation and rebalancing decisions."

He believes the disaster in Japan will prompt asset-allocation reviews across all asset classes, and multi-asset-class transitions should emerge as a result.

That said, Surrency does not see investors undertaking dramatic allocation shifts away from Japan. The traditional client base of transition managers comprises asset owners who manage against long-term investment horizons, he says. “So they will certainly be managing their portfolios against near-term risks, but we don’t see any wholesale sell-down of Japanese investment exposures occurring.

“The Japanese economy is the third largest in the world and comprises a resilient population and innovative companies,” adds Surrency. “Our clients recognise that and will be positioning their portfolios accordingly.”