Traders closely study how pensions funds, controlling $73 trillion, plan to spend their firepower. But lately, the industry’s biggest whales are creating outsized dislocation and trepidation in global currency and bond markets. The excessive market scrutiny and speculation that big pension funds are attracting now demands a rethink in portfolio management.
An unusual meeting at Japan’s Government Pension Investment Fund, or GPIF, in late August has sparked speculation that the $2 trillion manager will increase its current 25% allocation target for domestic bonds. Days later, Norway’s sovereign wealth manager proposed an overhaul of its government bond portfolio, potentially offloading US Treasuries but increasing holdings of Japanese debt because of a technical change in how the fund measures the market.
These separate but related developments have propelled a strong rally in the yen, creating a tricky situation for the Bank of Japan. Anything short of a hawkish hike at its meeting next week can be met with rapid selloffs in the country’s currency and sovereign credit.
It doesn’t have to be this way. When it comes to being on the frontier of investing, GPIF can certainly learn from America’s largest public pension program, the California Public Employees’ Retirement System, or CalPERS. In July, the $637 billion fund formally adopted the so-called “total-portfolio approach,” or TPA, making it the first US pension fund to do so.
By going with TPA, CalPERS has ditched rigid allocation bands to stocks, bonds and alternative investments. Instead, the fund will pursue a bottom-up approach to achieve the best returns possible. CalPERS notched a handsome 14.8% in the fiscal year ending June. But with a funding ratio of 85%, the system still doesn’t have enough assets to meet the future liabilities to more than 2 million members.
Meanwhile, GPIF — and most pension funds — still adhere to the traditional strategic asset allocation approach. The investment arm of Japan’s public pension program, with about 67 million enrollments, splits its portfolio into four equal-weight asset classes, allowing 5% to 6% deviation limits for each.
As a result, mechanical rebalancing can occur often. During the past quarter, a strong stock rally forced the fund to offload its equity holdings and buy bonds just to maintain its own mandate. This reshuffling, which dented returns, could have been avoided under the total-portfolio approach. Instead of obsessing over hitting fixed asset-class-weight targets, TPA asks if an investment improves the overall risk-return profile.
CalPERS switched to TPA because Chief Investment Officer Stephen Gilmore believes it can generate super returns. Over the last decade, adopters, including Australia’s Future Fund and the New Zealand Superannuation Fund, notched up 75 basis points in annualized excessive returns over the traditional approach, according to consulting firm Global SWF.
But more than higher capital gains, this year’s sharp market moves — driven in part by the global AI trade — are raising credibility concerns for managers who pigeonhole themselves into allocation limits. This problem is acutely pronounced with South Korea’s $1 trillion National Pension Service, or NPS, which bent its own rules in pursuit of better returns.
In late May, the Korean fund lifted its domestic equity target for the year to 20.8% from 14.9% to justify not selling its Kospi holdings. While having done well riding the year’s hottest stock rally, the NPS has to confront criticism as to why it was abandoning its long-term vision of global diversification, and whether its decision not to sell local shares exacerbated this summer’s retail frenzy and market volatility. The one big player that was supposed to tame the market was absent.
Under the total-portfolio approach, a pension fund wouldn’t have to make these kinds of very public and possibly embarrassing changes to its investment mandates. It allows money managers to focus on what they’re supposed to do — adding value for retirees — and nothing else.
By assigning equal weights to equities and bonds, as well as domestic and foreign assets, GPIF is acknowledging the diversification benefits of fixed income and globalization. But these assumptions are being challenged. The long-honored rule of holding a mixture of stocks and bonds failed to safeguard nest eggs during a global equities rout in 2022. With fiscal deficits on the rise, G10 countries’ government bond markets are more interdependent, as evidenced by US Treasury Secretary Scott Bessent’s attempts to beef up the yen.
With the investing universe in flux, TPA offers managers the flexibility to explore new optimal portfolios. The traditional approach, on the other hand, is coming across as clumsy and outdated. Japanese Health Minister Kenichiro Ueno, who oversees the fund, said that GPIF is still considering whether a review of its asset allocation is needed. Should it decide to tweak its targets, markets will ask if it’s an investment decision or a political one. It’s much harder to argue against TPA’s relentless focus on the overall return.
Granted, for TPA to work, collaboration is essential. Organizations need to break down the silo mentality across investment teams. Whether GPIF will adopt this modern experiment ultimately comes down to mindset. Is Japan’s biggest pension fund willing to change?
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This column reflects the personal views of the author and does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. A former investment banker, she was a markets reporter for Barron’s. She is a CFA charterholder.
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