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Zero yen hedge policy astounds Japan pension fund's own adviser
[TOKYO] Japan's US$1.1 trillion pension fund needs to hedge against the risk that a stronger yen poses to its growing pool of global stocks and bonds, said a member of its investment committee who was once a foreign-exchange trader.
"It's unbelievable" that the Government Pension Investment Fund, with 38.7 trillion yen (US$325 billion) in assets outside Japan, doesn't protect against fluctuations in the currency, said Junko Shimizu, a professor at Gakushuin University who also sits on GPIF's investment committee. "My personal opinion is that they should look to hedge." The world's biggest retirement-savings manager is paring domestic bonds on the assumption Prime Minister Shinzo Abe will succeed in stoking inflation, and moving that money into local stocks and investments outside Japan. Adopting a hedging policy would mean the fund is acknowledging the possibility of a stronger yen, an approach that clashes with the faith in Abe's policy programme that underscores its other changes.
"Exiting deflation, having a 2 per cent inflation target, stocks rising while the yen falls, that's all part of one big picture that is Abenomics," said Daisuke Uno, the Tokyo-based chief strategist at Sumitomo Mitsui Banking Corp. "GPIF increasing its foreign assets is a piece of this puzzle and means they're pricing in a weaker yen. Hedging would mean they're preparing for a stronger yen, and this goes against the Abenomics trend." GPIF said there are other hurdles, such as its size and policy of not predicting currency levels, which prevent it from changing its stance.
"We made our core portfolio without any currency hedging," Shinichirou Mori, director of the planning department at GPIF, said in a telephone interview on Thursday. "We don't make investment decisions based on currency forecasts. We wouldn't hedge based on a forecast."
Volatility in the US$5.3 trillion-a-day currency market surged last month to a 1 1/2-year high as central banks from Switzerland to Canada, Singapore and Australia shocked markets by easing policy. Gauges of price swings for the yen-dollar rate tripled since July.
The GPIF overhauled its investment strategy in October, boosting its target for foreign bonds to 15 per cent from 11 per cent, while lifting goals for domestic and overseas stocks to 25 per cent each from 12 per cent each. It reduced domestic bonds to 35 percent from 60 per cent.
"It's possible to skilfully combine cash, futures and options as a way of hedging currencies," Shimizu said in an interview last week. She spent more than a decade through to the mid-1990s dealing in foreign exchange for companies including Chase Manhattan Bank, Bank of America Corp. and Morgan Stanley. "As GPIF's scale is so big, firstly we need to consider whether this combination is realistic or not." That's also an issue concerning GPIF's Mori.
"With the fund's assets being so big, we have a problem with whether the market can absorb it if we start doing things such as currency futures," Mori said.
California Public Employees' Retirement System, with US$296.1 billion in assets, said in 2013 that it would increase active foreign-exchange hedging and scrap its passive currency overlay program. A passive overlay showed no signs of reducing volatility or increasing returns, Calpers said.
The Canada Pension Plan Investment Board, with C$234.4 billion (US$187.4 billion) in assets under management and is often referred to as a model retirement fund by GPIF's advisers, said there are benefits to hedging foreign debt but not overseas equities.
Hedging overseas bonds reduces volatility and allows them to act as a substitute for Canadian debt, the fund said in its 2014 annual report. Foreign equities, however, see little impact on return volatility from hedging, plus the cost of doing so in many developing countries is "prohibitively high," the report said.
Proponents of hedging say Japanese funds are among those with the biggest reason to do so because the yen's status as a perceived haven means the currency often gains during crises, potentially exacerbating sudden declines in global equities. Opponents say the costs of hedging outweigh the benefits.
A Japanese money manager would have seen a 32 per cent loss on the MSCI All-Country World Index for the final four months of 2008 expand into a 43 per cent tumble in yen terms if the holdings weren't hedged. The Bank of America Merrill Lynch Global Broad Market Index of bonds made a 14 per cent loss in yen terms, versus a more than 2 per cent gain when hedged.
The yen slumped 35 per cent against the US dollar over the past three years as Abe came to office and instituted economic policies of monetary easing, fiscal stimulus and structural reform.
"When there's a move toward taking risk off, the yen usually rises in tandem with foreign stocks declining, so there's a double whammy on losses," said Yuji Kameoka, chief foreign-exchange strategist in Tokyo at Daiwa Securities Co. "With an increase in foreign stocks and bond investments, the significance of hedging has become more prominent" for GPIF.
The fund hasn't responded to previous calls for it to adjust its policy of not hedging against currency fluctuations. A government pension advisory panel led by Takatoshi Ito said in 2013 the GPIF should consider hedging policies, given rapid changes in the economy and markets.
"GPIF has about 80 people now, but they will get bigger," said Shimizu. "For example, it would be good if they consider hiring someone in charge of currency strategies."