“Lack of public faith in the markets is our biggest problem”

A leap in the dark

The current state of Japan’s pension system

Text by David McNeil  /  Illustration by Guillaume Babusiaux

With Japan’s demographic time bomb ticking, how will the government fund millions of retirements? And how will its pension reforms affect Europe?

Until recently, the office of the planet’s biggest public pension pot could be found in a dingy old building in central Tokyo. However, the Government Pension Investment Fund (GPIF) now resides up the road in the swanky Mori Tower, among the movers and shakers of the global finance industry.

In 2014, after years of hectoring by everyone from politicians in the Liberal Democratic Party (LDP) to billionaire investor George Soros, Japan’s government finally began pulling the ¥139.8 trillion fund out of the hands of risk-averse bureaucrats and into the light of 21st century capitalism.

Reformers said this was necessary because, after years of investing in little more than domestic government bonds, the fund’s rates of return were too measly. The Economist had described the GPIF investment strategy as little better than stuffing yen into mattresses.

The reform is being watched closely. Across the developed world, pension funds are grappling with a major headache: how to pay for the retirement of millions of people as populations age and fewer pay contributions. The dilemma perhaps runs deeper in Japan than anywhere else.

Japan is one of the planet’s oldest societies, with a median age of 46.5 years. By 2060, the population is projected to fall from 127 million to 87 million, of which almost 40% will be 65 or older.

The working population, meanwhile, has declined by 10 million over the last two decades, says Kosuke Motani, a senior economist at the Japan Research Institute, a think-tank. Millions more workers will be lost in the coming years unless the government opens the drawbridge to immigration, which it has shown little sign of doing.


Millions of people with raw memories of the bubble economy think bourses are a “virtual world” where money can just melt away


The asset mix of Japan’s pension fund has altered dramatically since the reform began. According to the GPIF, the percentage of all equity holdings has doubled, with international holdings going from 12% to 22%. Domestic holdings of government bonds, meanwhile, have fallen sharply from 60% to about 37%.

There was, however, instant scepticism of the strategy among some politicians, trade unions and even the fund’s then-president, Takahiro Mitani. Many accused Prime Minister Shinzo Abe and the government of gambling with pension money to drive the stock market up — one of the few tangible successes of Abe’s inflationary creed.

The flak reflected the conservatism and deep unease of Japanese investors concerning stocks, admits Shinichiro Mori, spokesman for the GPIF. “Lack of public faith in the markets is our biggest problem,” he laments. Millions of people with raw memories of the bubble economy think bourses are a “virtual world” where money can just melt away, he explains.

Some of those fears appear to have been vindicated by the recent performance of the Nikkei Average. After a turbo-charged initial run under Abe, the Nikkei’s rise has stalled and this year stocks have seen their worst performance since the global financial crisis of 2008. Many analysts predict a rocky patch ahead for global markets and, some say, another even deeper crash could be around the corner.

These uncertainties mean the GPIF’s sharp asset diversification is in temporary hiatus, says Masamichi Adachi, senior economist at JPMorgan. World equity markets again look, in his words “bubbly.” A collapse in the next few years could ruin confidence in the pension strategy and be politically costly to the Abe government, he predicts.

Still, there is probably no going back. Japan’s looming demographic crash means keeping the old system intact is simply not an option, according to Takehiro Noguchi, senior economist with the Mizuho Research Institute. And because the GPIF is such a key cog in Japan Inc., its reform is already sending ripples out across the entire economy.

For one thing, the more daring GPIF is already helping to nudge firms in which it owns shares into overhauling management. The shifting of the fund’s giant bulk could have a major impact on stewardship in Japan and “lead to better corporate governance and better companies,” believes Hans-Christoph Hirt of British fund manager Hermes Investment Management.

Some say this isn’t enough. The fund is banned from directly investing in stocks or trading in derivatives, partly because many fear its enormous clout on the markets if let loose. Its investment targets are still relatively modest. The GPIF, as it stands, has one foot in the old world of the Ministry of Health, Labour and Welfare’s bureaucrats, and one in the world of professional high finance.

The personification of this dual identity is Hiromichi Mizuno, the chief investment officer hired by the GPIF in 2014. Once a Ferrari-driving private-equity executive in London, Mizuno now rides a bike to work and is paid a fraction of what he once earned. Under him, the fund has hired investment professionals, issued a code of conduct, and demanded more freedom to invest.

The fund’s managers are likely to face a rough ride in the event of a major stock-market crash. Mori believes they will try to argue that — while investment income plummeted in 2008, and has been negative since 2014 — the long-term trend is clearly up. He says the fund’s average annual rate of return of almost 3% from 2001 to 2015 is well above wage inflation, and will expand in the years ahead.

Some of the investment has already trickled into European bonds, one of the few markets with yields, according to Martin Schultz, a senior research fellow with Fujitsu Research Institute. He sees a gradual exposure to world markets, starting with safer assets. “The managers have already been burned because the yen is stronger and stock markets are down,” he explains. “These conservative fund managers don’t like that, neither does the public, so it will be a very gradual approach.”

Nicolas Sauvage, representative director at Amundi Japan and chairman of the EBC Asset Management Committee, points to the appeal of the current conditions in Japan for foreign companies. “The evolution of the pension system in Japan is offering a broad range of opportunities to the European asset management industry, even though it is a very competitive area,” he explains. Sauvage predicts that “despite the recent market volatility, pension funds will continue to reorganise their asset allocation and to diversify investment strategies … even in alternative investments like infrastructure.”

And there is no shortage of invitations to invest the money. Noguchi of Mizuho would like to see more go into domestic infrastructure projects. Yasuyo Yamazaki, a former investment banker who heads the country’s largest solar-energy project, says it could help provide the ¥6.5 trillion needed to subsidise renewable energy such as solar and wind, and upgrade the electricity grid.

The trillion-yen question is whether all this will help to fund the retirement of 67 million Japanese. On that, the jury is out. Adachi believes that reforming the pension fund must be part of a broader strategy to raise economic growth, fix Japan’s creaking finances, and cut public debt. “The pension fund is supposed to service the next 100 years,” he says. “It is still very difficult to conclude [whether it will be a] failure or success.” •

Japan has a median age of 46.5 years. By 2060, the population is projected to fall from 127 million to 87 million, of which almost 40% will be 65 or older.