Part 1: Pension Funds
Summary
This blog delves into the landscape of hedge fund investments in Japan. It explores the various types of investors in Japan and conducts an analysis of the financial assets held by major entities, placing particular emphasis on pension funds as significant participants. Additionally, the blog provides a historical overview of pension fund management in Japan, highlighting pivotal policy changes that afforded pension funds greater autonomy and facilitated a shift in asset allocation. Lastly, the blog introduces The Pension Fund Association (PFA) and offers insights into 47 corporate pension funds that have ventured into hedge fund investments.
Introduction
Do Japanese investors participate in global hedge funds? Indications suggest so, as 20 out of the top 100 global hedge funds have established offices in Tokyo [1]. This suggests a belief in the potential for attracting clients in the region.
Now, who constitutes the target investors in Japan?
In the United States, hedge fund investors typically include endowments, foundations, pension funds, sovereign wealth funds, funds of funds, family offices, insurance companies, registered investment advisors, and high-net-worth individuals [2]. Is the same applicable in Japan? Determining this is challenging due to the confidential nature of the private investment universe. Nevertheless, some insights can be gleaned from publicly available information.
The following graph illustrates the financial assets held by major asset holders in Japan who are likely candidates for hedge fund investments:
Source:
Bank of Japan. Annual data of flow of funds for fiscal year 2022 released on Sept. 20, 2023.
Nomura Research Institute, Ltd. 日本の富裕層は149万世帯、その純金融資産総額は364兆円と推計. As of March 1, 2023. Retrieved November 28, 2023.
Note: At the exchange rate of 150 yen per US Dollar.
Sovereign wealth funds are not present in Japan, primarily due to the country's absence of significant natural resources, such as oil or gas, and the central government's persistent deficits [3]. Family offices are also uncommon in Japan for various reasons, including the post-World War II dismantling of business conglomerates and the preference of Japanese corporations to establish business groups rather than family offices.
For the purpose of this blog, the emphasis will be on the second-largest category, pension funds (depicted by the orange bar in the graph), which are recognized as typical investors in hedge funds.
Which pension funds are investing in hedge funds?
Let's examine the five categories of pension funds in Japan.
Source: Pension systems and sustainability: - Japan. Principles for Responsible Investment (PRI). Retrieved on November 29, 2023.
Note: At the exchange rate of 150 yen per US Dollar.
Among the funds in the graph, the Government Pension Investment Fund (GPIF; represented by the red bar) is the sole public entity. On the other hand, while the National Pension Fund Association (depicted by the purple bar) may sound like a public entity, it is not.
Good news and bad news
Bad news first.
The world's largest pension fund, the Government Pension Investment Fund (GPIF), refrains from investing in hedge funds due to several reasons:
Hedge funds are exclusively available to accredited investors with the resources to comprehend complex strategies and unique risks. However, the GPIF is significantly understaffed, employing only 172 individuals to manage a massive portfolio of 1,334 billion US dollars. This equates to nearly $8 billion per employee, a figure 47 times larger than the California Public Employees' Retirement System (CalPERS) [4] [5].
The GPIF maintains a policy against short-selling [6].
Designed for a lifespan ranging from 20 to 100 years, the GPIF is strategically positioned to pursue illiquidity premiums on long-term private equity investments, such as infrastructure and real estate [7] [8] [9].
In addition to the GPIF, three other categories of pension funds are not known to invest in hedge funds:
Defined-contribution type corporate pension funds (depicted by the yellow bar), similar to the U.S. 401k, avoid direct investments in hedge funds due to their membership consisting of company employees who are typically not accredited investors.
The National Pension Fund Association (represented by the purple bar) restricts its investments to stocks, bonds, bank loans, and real estate [10].
Defined-contribution type personal pension plans (illustrated by the green bar) cater to general retail investors and are, therefore, deemed unsuitable for hedge fund investments.
Finally, the good news.
Defined-benefit type corporate pension funds (represented by the blue bar), boasting total assets of 74.5 trillion yen (approximately 497 billion in US dollars), do engage in hedge fund investments. However, it's essential to note that these funds have encountered challenges and setbacks in the past, including losses incurred from a fraud. The details of their experience are outlined below.
History of defined-benefit type corporate pension funds
Once upon a time, managing pension funds was a breeze
During Japan's rapid post-World War II growth, overseeing pension assets was a piece of cake. Corporations enjoyed an abundance of young workers and fewer retirees, facilitating the swift accumulation of funds. Their primary investments were in domestic loan assets and bonds, generating remarkable returns ranging from 8% to 10%. When choosing external money managers, selection criteria focused on capital or business relationships rather than performance because all products guaranteed similarly robust returns [11].
The paradise was lost
In 1990, Japan's bubble economy burst, with the Nikkei stock index losing half of its value in just nine months. The economy experienced a slowdown, and interest rates continued to decline, eventually reaching near-zero levels (below).
Japan 10 Year Government Bond Interest Rate
Source: Ministry of Finance, Japan. 国債金利情報 [translation: Government Bond Interest Rate data]
External money managers could no longer assure high returns. Among the most severely affected were a type of corporate pension funds known as "kosei" pension funds, a hybrid of public and private pension funds. By law, corporations were permitted to collect premiums for national pension insurance policies from workers' salaries and retain a portion to commingle with their private pension assets. During prosperous periods, corporations benefited from managing both public and private fund portions, enjoying economies of scale. However, in challenging times, the government-imposed assumed investment return, fixed at a rate of 5.5%, became a significant burden. As a result, many kosei pension funds became underfunded.
The government granted them the freedom to sink or swim
Six years after the collapse of the bubble economy, Japanese policymakers deregulated the financial market, providing pension funds with greater freedom of choice. Previously, pension funds were only allowed to award mandates to insurance companies and trust banks. Now, they can also engage investment advisers. Restrictions on asset types and allocation limits were completely lifted, enabling pension funds to reduce their bond holdings and venture into alternative assets. Cross-border transactions and derivatives transactions were liberalized as well [12].
Consequently, the composition of their assets underwent a transformation (depicted below).
Source: The Pension Fund Association. 企業年金実態調査結果（2021年度概要版）. Survey results of 2,975 funds.
The funds also began engaging investment advisers to manage larger portions of their assets (illustrated below).
Source: The Pension Fund Association. 企業年金実態調査結果（2021年度概要版）. Survey results of 2,975 funds.
Many large corporations successfully returned the public portion of their pension funds to the government and established purely private corporate pension funds. Overall, the performance of corporate pension funds was commendable (depicted below).
Source: The Pension Fund Association. 企業年金実態調査結果（2021年度概要版）. Survey results of 2,975 funds.
However, pension funds of small- and medium-sized firms were not as fortunate. Due to the adverse impact of Japan's stagnant economy on the business of plan sponsors, they struggled to bridge the funding gaps. Terminating the funds was also not a viable option, as it necessitated making the public portion of assets whole before transferring them to the government. They found themselves at the end of their rope.
Kosei pension funds fell victim to fraud
In the early 2000s, the hedge fund company AIJ Advisors began approaching distressed kosei pension funds of small- and medium-sized firms. AIJ presented performance records that appeared too good to be true (depicted below):
Track record shown by AIJ to pension clients (%)
Source: Hidekazu Nagamori, (2013) 年金詐欺 AIJ事件から始まった資産消失の「真犯人」[Translation: Pension Fraud: "Real culprits" in asset loss that began with the AIJ case] , Kodansha.
The above figures were all fabrications. AIJ provided false Sharpe ratios, made deceptive promises of exiting positions to cut losses in adverse scenarios, and imposed a one-year lockup period.
For AIJ, selling its services was an easy job. The company was led by Kazuhiko Asakawa, a former top salesman at Nomura with a persuasive manner, akin to the lead character in the film "The Wolf of Wall Street." In contrast, kosei pension funds were typically overseen by former bureaucrats with no background or expertise in investments, often transitioning from Japan's Social Insurance Agency (an agency later disbanded due to corruption and scandals). These directors rarely inquired about risk management practices with AIJ.
Asakawa indulged in extravagant wining and dining of pension clients, offering gifts, and even resorting to bribery.
When the police arrested Asakawa in 2012, AIJ had incurred a staggering 94% loss of its Assets Under Management (AUM). The total loss amounted to 137 billion yen, approximately 5% of what Bernard Madoff lost. The incident became a national scandal because AIJ had an impact on 74 kosei pension funds, representing one-tenth of this type of funds across Japan. Many of these funds had failed to diversify (illustrated below).
Source: The Ministry of Health, Labour and Welfare. ＡＩＪ投資顧問株式会社に投資残高のある基金について[Translation: Funds with investment balances in AIJ Investment Advisors CO.,LTD.]. As of the end of FY2010.
Asakawa testified before the parliament, expressing confidence in recovering the losses by placing additional bets. His strategy involved writing options on the Nikkei stock index futures. However, he proved to be an undisciplined investor with a penchant for gambling. In 2013, he was sentenced to 15 years in prison.
Following the incident, the government made the decision to abolish kosei pension funds. Today, only a few of them remain (depicted below).
Source: The Pension Fund Association. 企業年金実態調査結果（2021年度概要版）. Survey results of 2,975 funds.
Corporate pension funds today
Despite the scam that stained the reputation of hedge funds, Japanese corporate pension funds still harbor an appetite for hedge fund investments. Katsuyuki Tokushima at NLI Research Institute notes that Japanese corporate pension funds are expressing interest in hedge funds pursuing absolute returns through non-directional arbitrage strategies. Given that markets for such strategies have not been well-developed in Japan, these funds are turning to overseas hedge funds for opportunities [13].
The remainder of this blog will introduce some of the larger corporate pension funds that invest in hedge funds.
The Pension Fund Association (PFA)
The Pension Fund Association (PFA) serves as an umbrella organization for 1,215 funds, with the majority being of the defined-benefit type. Additionally, the PFA manages its own fund, inheriting pension assets from individuals who left pension schemes after a brief period or from funds of bankrupted companies. As of March 31, 2023, the PFA boasts total assets of 12 trillion yen, with 910 billion yen (USD 6 billion) allocated to hedge fund investments [14].
Corporate pension funds
An analysis of publicly available information reveals 47 corporate pension funds that have invested in hedge funds, as detailed in the table below.
In the "actual" cell, the exact amount allocated to hedge funds in FY2022 is provided, while the "less than" cell denotes the investment in alternative assets, encompassing hedge funds.
The table includes the funding rate, a metric indicating the health of the pension fund. This rate is computed by dividing pension assets by employees' benefit liabilities. Pensions at 100% or higher are deemed robust, while rates below 80% have historically been considered unhealthy [15]. Pensions falling below 60% are likely unsustainable [16].
Corporate pension funds typically assume investment returns ranging between 2.0% and 3.0%.
Source:
Financial Service Agency. Electronic Disclosure for Investors' NETwork.
The Pension Fund Association. 会員名簿 [Translation: The member list]. As of November 1, 2023.
Websites of the corporate pension funds.
Final Remarks
I trust that this blog effectively addresses the question, "Who invests in hedge funds in Japan?" It's important to note, however, that the above list is not exhaustive, and there may be additional pension funds interested in hedge fund investments. The comprehensive list of 688 corporate pension funds can be accessed here: https://www.pfa.or.jp/gaiyo/meibo/files/meibo_kaiin.pdf
The exploration for more information is in your hands. Happy discovering!
Acknowledgments
I would like to extend my gratitude to Sam Pellettieri, CEO and Chief Investment Officer at Altema Asset Management Inc., for sparking the investigation into Japanese family offices with his inquiry. Special thanks to Vincent Au, Chief Investment Officer at Gondor Capital Management LLC, for highlighting the challenge of obtaining information about Japanese institutional investors. Additionally, I appreciate David Dredge, Chief Investment Officer at Convex Strategies Pte Ltd, for expressing interest in reading my blog about pensions.
References
[1] Top Hedge Funds. Retrieved on December 24, 2023. WallStreetPrep; The official website of each hedge fund. The websites of these companies.
[2] Dassani, Hemali; Kuppuswamy, Nanda, (2022) Marketing Alternative Investments: A Comprehensive Guide to Fundraising and Investor Relations for Private Equity and Hedge Funds, McGraw Hill LLC., p. 28.
[3] 日本の財政問題. Wikipedia. Retrieved November 29, 2023.
[4] Annual Report Fiscal Year 2022. GPIF, p. 3 and p. 85.
[5] CalPERS. Wikipedia. Retrieved November 29, 2023.
[6] Short sellers under fire from investment boss of world’s largest pension fund. Financial Times. Retrieved November 29, 2023.
[7] Yohei Komamura, (2014) 日本の年金 [Translation: Pension in Japan], Iwanami Shoten.
[8] Manabu Shimasawa, (2019) 年金「最終警告」[Translation: Pension - Final Warning], Kodansha.
[9] Yoichi Takahashi, (2017)「年金問題」は嘘ばかり ダマされて損をしないための必須知識 [Translation: The "pension issue" is full of lies - Essential knowledge to avoid being deceived and losing money]. PHP Kenkyusho.
[10] 2022年度運用報告書. As of March 31, 2023. National Pension Fund Association. Retrieved November 28, 2023.
[11] Hidekazu Nagamori, (2013) 年金詐欺 ＡＩＪ事件から始まった資産消失の「真犯人」[Translation: Pension Fraud: "Real culprits" in asset loss that began with the AIJ case], Kodansha.
[12] Stephen M. Harner, (2000) Japan's Financial Revolution and How American Firms are Profiting, Routledge.
[13] Hiroshi et al., (2017) マイナス金利と年金運用 [Translation: Negative Interest Rates and Pension Investment], Kinzai, p. 187.
[14] 2022年度 年金資産の運用状況（概況）. The Pension Fund Association.
[15] Tobe, Chris, (2018) Kentucky Fried Pensions, CreateSpace Independent Publishing Platform; 3rd edition, p. 21-22.
[16] Bloomberg. 'Death Spiral' Besets State Pensions as Benefits Grow.