June 16 (Bloomberg) -- Japan’s public pension fund, the world’s largest with about 120 trillion yen ($1.2 trillion) in reserves, said it may sell Japanese government bonds this year to cover payments to retirees.

The Government Pension Investment Fund, the biggest buyer of the nation’s government bonds, won’t receive more money from the state after it was made independent in 2006, President Takahiro Kawase said.

“The big change this year for us is that there is zero new money to invest, so we may need to be a seller in the market to meet the pension benefits,” Kawase, 67, said in an interview in Tokyo yesterday. “Our bond allocations are overweight, so we may need to reduce those a bit to raise cash.”

Sales by the fund could compound weakness in Japanese bonds, which declined during the last four weeks, the longest stretch of losses in a year, on speculation rising supply will deter investors from buying the securities. Selling into a falling market makes it more difficult for the fund to boost returns after posting a 5.7 trillion yen loss on investments for the three months ended Dec. 31.

Kawase declined to estimate the amount of bonds the fund, also known as GPIF, may sell.

Declining returns come as GPIF needs to improve its performance to cope with the world’s most rapidly aging population. The government estimates that a quarter of the nation may be drawing pensions by 2025.

The fund had 76 percent of its investments in domestic bonds, 9.5 percent in domestic equities, 7.8 percent in overseas bonds and 6.7 percent in international stocks as of the end of December, according to the latest figures released in February.

Yields Climb

Yields on 10-year Japanese government bonds last week climbed to the highest level since October on concern that Prime Minister Taro Aso will increase public spending to secure votes at an election he must call by Sept. 10.

Demand for debt also waned on signs the world’s second- largest economy is recovering after the Cabinet Office said the economy shrank last quarter by less than originally reported.

The yield of the benchmark 10-year bond fell 1.5 basis points to 1.485 percent at 11:05 a.m. in Tokyo today.

By contrast, the Nikkei 225 Stock Average closed above 10,000 points on June 12 for the first time in eight months. The benchmark has gained about 30 percent in the past three months.

Under former prime minister Junichiro Koizumi, the fund, then part of the Ministry of Health, Labor and Welfare, became an independent institution in April 2006.

Although formally independent, the government still dictates that GPIF follow a portfolio model set by state until the end of the current fiscal year through March 31. Domestic bonds must account for 67 percent of investments, local stocks 11 percent, foreign debt 8 percent and overseas shares 9 percent.

Kawase said this is close to previous allocations and a future model to be developed by GPIF is likely to be similar.

To contact the reporters on this story: Tomoko Yamazaki in Tokyo at tyamazaki@bloomberg.net; Komaki Ito in Tokyo at kito@bloomberg.net

Last Updated: June 15, 2009 22:32 EDT