Why Japan's GPIF will bite the bullet over FTSE Russell index China inclusion

China bonds are now too big to ignore - even for Japan's (and the world's) biggest pension fund. That said, GPIF and China are set to make odd bedfellows on the world bond index.
Why Japan's GPIF will bite the bullet over FTSE Russell index China inclusion

Japan's Government Pension Investment Fund (GPIF) is expected to adopt the FTSE Russell’s World Government Bond Index (WGBI) despite China’s inclusion on the index – a move the pension fund opposed – due to the fact China bonds are outperforming, observers say.

China sovereign bonds will be gradually included in the index over a period of three years starting at end of October 2021. Their eventual weighting is expected to reach 5.25% of the index, prompting foreign investors to recalibrate their China bond investments despite concerns.

GPIF, which had ¥177.7 trillion ($1.63 trillion) in assets at the end of last year, was reportedly among Japanese investors that opposed the decision. The pension fund has said it will decide in the coming months whether to continue to invest via the FTSE Russell’s flagship bond index.

A GPIF spokeswoman said the pension fund invested ¥1.6 trillion in Chinese equities and did not hold China bonds as of March 2020. She declined to comment further.

Market experts told AsianInvestor they were inclined to believe that GPIF would still adopt the index, there were also contrarian views.

Yoshikazu Kato

“My biggest reason to say it’s possible [that GPIF will continue to use the index] is that engaging with China is a global trend that nobody, including Japan, can neglect,” Yoshikazu Kato, research fellow of Economic Research Institute at Rakuten Securities, told AsianInvestor.

On the basis of rational assessment alone, the performance of the bond market has been attractive. Japanese manufacturing or service industries have had long-standing ties with the Chinese mainland, and therefore Japanese investors have been increasingly connected with the Chinese financial market, including the bond market, he said.

China’s 10-year sovereign bonds were yielding about 3.19% on April 26, well above the 0.08% for Japanese 10-year sovereign bonds and 1.56% for 10-year US Treasuries.

Many bond indices now include China bonds and GPIF - while it may choose to use a customized index without China bonds - had barely any good reason to use an ex-China bond index, Atsuhito Mori, managing director and head of asset management department at ORIX Bank Corporation, told AsianInvestor.

JP Morgan in February 2020 and Bloomberg Barclays in March 2019 respectively have also begun including China bonds in some of their benchmark products.

Katsuyuki Tokushima

However, Katsuyuki Tokushima, head of pension research & ESG development at NLI Research Institute, voiced his concerns over China bonds.

“Higher yields [of China bonds] may only reflect higher risks. As long as Japan’s investors fear sudden possible capital restrictions or troubles in China, their investments into China will not be huge at first,” he said.

China's bond market is the second largest in the world, standing at a staggering Rmb117 trillion ($18 trillion) at the end of 2020. The foreign ownership ratio is 3% for the market as a whole, and 9% for government bonds, according to DBS.


Most of the concerns raised by Japanese investors in a December meeting with the index provider focused on technical aspects, such as the lack of full convertibility in the Chinese renminbi and some bond liquidity and settlement issues.

On that front, FTSE Russell said Chinese authorities have significantly enhanced their fixed income market infrastructure, including improving secondary market bond liquidity and developing global settlement and custody processes. 

Atsuhito Mori

Technical issues aside, some market observers say that historical mistrust betwen Japan and China could also be playing into market apprehensions. 

“A lot of Japanese investors always see China emotionally and politically, (and) tend to make a point of the country risk,” Kato said, adding that GPIF should steer clear of these political considerations.

While Japan has increasingly perceived China's increased assertiveness as a threat to security and prosperity, the robust returns of China bonds and the growing importance of Japan's economic and financial ties with China meant GPIF could not abandon the Chinese market on the basis of political reasons along, he said.

Mori said that GPIF needed to respond to its fiduciary duty to its pension stakeholders rather than bow to political pressure.

Other pension funds in Japan may have stricter criteria on whether or not to invest in China bonds, but if GPIF ended up investing in these assets, the others were likely to follow suit, he said.

GPIF is one of the biggest users of the index - currently tracked by roughly $2.5 trillion of assets - and it is estimated that Japanese investors represent as much as 80% of funds pegged to the index.

China government bonds will be added to the WGBI over a lengthier phase-in period of 36 months, compared with the previous announcetont of 12 months, with FTSE Russell citing considerations over "material monetray inflow" after the inclusion.

Moreover, 47 China government bonds will be eligible to be included in the index compared with the original 78 as FTSE Russell finally decided that bonds with a minimum size of Rmb100 billion were eligible instead of the original Rmb35 billion.

Total foreign inflows into China bonds would be $131.2 billion at the end of the lengthy phase-in period, according to Nomura.

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