OECD reserve funds. The OECD‘s 2009 Economic Survey of Japan notes that is it is questionable whether the current portfolio can generate returns consistent with the GPIF‘s projection.
The strategic asset allocation of the fund also does not seem to have been set with any consideration for the liabilities of the public pension system – which the OECD recognizes as important in developing investment strategies and fund objectives.18 The GPIF could therefore be exposed to unrealized duration risk and asset-liability mismatch.
c) Prudent Person – diversification + risk management
The OECD guidelines note that the approach for achieving the investment objectives should satisfy the prudent person standard, taking into account the need for proper diversification and risk management etc.
The reserve funds usually face additional restrictions intended to ensure diversification or to avoid direct control of corporations.
The Japanese GPIF‘s investments are mainly restricted to domestic listed bonds and equities – this being the outcome of the medium term investment plan developed by the GPIF and approved by the Ministry of Health, Labour and Welfare. The investment policy excludes any allocation to alternative investments and allows the use of derivatives for hedging purposes only. 19 The fund‘s investment committee has also established additional investment limitations (the portfolio invested in foreign bonds must be less than the portfolio invested in foreign equities which in turn must be less than the portfolio invested in domestic equities). There is little apparent justification for such a rule, which is unique among OECD reserve funds.
The Japanese GPIF‘s investment policy also sets a ceiling of 5% of its assets in securities issued by a single company and it limits its ownership of a given company to 5% of the firm‘s equity – which is generally in line with its peers and OECD practice – but could provide a practical constraint given the size of the fund (i.e. forcing it to make many investments for a small % of the AUM). This may also prevent private equity investments. The GPIF is also not expected to exercise directly shareholder rights but may do so only via the private financial institutions to whom investment is entrusted.
18 Mitchell et al (2008), in their analysis of pension reserve funds, note that: "The important lesson which emerges from these analyses is that investment policies which fail to take into account the payout paths can be misleading and potentially quite suboptimal. Therefore the lesson is that, in addition to paying attention to the efficient risk-return wealth frontier, fund managers should also take into account the ability of the fund to meet other objectives (e.g. not raising taxes too sharply on any given generational in event of a revenue shortfall."
19 Indirect investment in alternatives is allowed via trust contracts with financial institutions, etc. - though currently none are undertaken and would require approval from the MHLW in case such investment would go beyond the basic portfolio, which will require the revision of the mid-term plan.