AIJ Probe by Japan Regulator Undermines Pensions Alternative Asset Plans

The suspension of AIJ Investment Advisors Co.’s operations amid concerns hedge funds it manages had lost pension money may undermine plans by Japan’s retirement funds to boost returns to meet demand in an aging society.

The Financial Services Agency on Feb. 24 ordered the Tokyo- based firm with 183.2 billion yen ($2.3 billion) of client money to stop business for a month as the regulator investigates “possible losses” at AIJ’s hedge funds. The FSA also will undertake a nationwide probe of 263 asset managers.

“If the funds actually suffered losses, this could potentially have a massive impact on pension plans that actually invested with them,” said Taro Ogai, who oversees consulting for pension fund investments at Towers Watson in Tokyo. “Pensions already face difficulties. At a time when they are trying to boost returns and cut risks, investing in hedge funds may become difficult for them.”

The inquiry is a setback for Japan’s pension industry that has been looking to diversify away from bonds and equities into alternatives investments, including hedge funds, to maintain steady returns and fund retiree benefits in a country with the world’s fastest-growing aging society and two decades of slumping markets. It also raises questions about the nation’s corporate governance after camera maker Olympus Corp.’s admission that it covered up losses by overpaying advisers.

Non-Traditional Strategy

Regulators have been investigating AIJ, which invests in futures and options of equities and bonds, since the end of January, and discovered that the company has been unable to explain to investors the current state of the way their money is being managed, according to the FSA.

AIJ is registered in Japan by the FSA as a so-called discretionary investment manager, which can include fund managers that employ hedge fund strategies.

Pensions view AIJ as a hedge fund because its strategies aren’t tied to simply buying and selling traditional asset classes such as bonds and equities. Alternative investments also include private equity funds, real estate, commodities and infrastructure.

AIJ’s funds have been traced from Japan to the Cayman Islands, followed by a trust bank in Bermuda and ultimately to “a major European Bank” in Hong Kong, the Asahi newspaper said Feb. 25, citing an investigation by Japan’s Securities and Exchange Surveillance Commission. AIJ kept money-flow records up to the unidentified bank in Hong Kong and no further records have been found, the newspaper said.

Pension Returns

AIJ may have lost most of the 200 billion yen it manages for companies’ pension plans, the Nikkei newspaper reported Feb. 24, citing unidentified securities investigators.

The investigation into Japan’s 263 asset managers may be one of the biggest into licensed managers in the nation, said Mitsushige Akino, who oversees about $600 million at Ichiyoshi Investment Management Co. in Tokyo.

The investigation into whether the 263 are disclosing performances to their clients and how they are managing their money will begin today, Kyodo News reported.

Japan’s financial regulator is also planning to investigate trust banks that handle pension money as well as corporate pensions, the Nikkei newspaper reported over the weekend.

The regulator penalized at least 35 financial institutions last year including Citigroup Inc. and UBS AG for breaching securities rules, according to its website.

Weak Market Performance

Japanese pension plan returns have been hurt by low bond yields, an aging population and the world’s worst-performing stock market in the past 20 years. People 65 years or older will account for 29 percent of the population in 2020 and almost 40 percent in 2050, while the Nikkei 225 Stock Average (NKY) is at a quarter of its 1989 peak. The 10-year Japanese government bond yield is at 0.968 percent, second-lowest after Switzerland.

AIJ, led by Kazuhiko Asakawa, was established in April 1989, and had 120 clients including pension plans with 183.2 billion yen in assets as of the end of 2010, according to a statement from the FSA. It has 12 employees. Phone calls to AIJ’s main office were answered by an automatic recording which didn’t allow messages to be recorded.

Asakawa said the firm’s profits won’t be dependent on the rise and falls of the markets as it uses a complex financial technology, the Wall Street Journal reported today, citing his message on an archived webpage of AIJ. The page is no longer on its website.

‘Not Enough’

“The size and age of an investment management firm is not enough to rely on,” said Rory Kennedy, chief operating officer in Tokyo at Rogers Investment Advisors K.K., which allocates money to hedge funds. “This incident once again proves the clear need to use experienced professionals to perform due diligence when investing in any area in which you are not an expert.”

Asakawa was a former employee at Nomura Holdings Inc. (8604), according to a person familiar with his employment. Keiko Sugai, a Tokyo-based spokeswoman at Nomura, declined to comment.

AIJ’s fund was ranked top among pension funds in 2008, said Fujio Nakatsuka, a spokesman at Rating & Investment Information Inc. in Tokyo. He said the rankings were based on responses from pensions and not what R&I had recommended to investors.

The hedge fund industry has come under scrutiny in the past four years, since the collapse of hedge funds run by Bear Stearns Cos. in 2007. Bernard Madoff was arrested in 2008 for operating the largest Ponzi scheme in U.S. history and hedge fund Galleon Group LLC co-founder Raj Rajaratnam was found guilty in May on insider-trading charges.

Proper Due Diligence

“Pension funds need to acquire financial literacy to do proper due diligence to figure out the risks as it becomes easier for different types of people to enter the market,” said Tetsuo Tanimura, the head of hedge fund consulting firm C2G Advisors Co.

Advantest Corp. (6857), a maker of memory-chip testers, said in a statement it has 1.7 billion yen, or about 8 percent of its total corporate pension fund, invested with AIJ. Yaskawa Electric Corp. (6506) has about 2 percent of its pension money managed by AIJ and the impact will be limited, said Ayumi Hayashida, a spokesman at the company.

The truck driver pension union in Fukui prefecture has invested about 300 million yen in AIJ through a brokerage, said Kazuyuki Hashimoto, an adviser to the retirement plan.

Due diligence on hedge funds will probably become stricter, while the importance of so-called gatekeepers that introduce investments to funds will increase, said Takafumi Sahoda, founding president of Darwin Capital Partners Ltd., a Japanese hedge fund.

‘Massive Failure’

“Pension funds have been reluctant to put money directly into hedge funds and majority of them have done through fund-of- hedge funds,” said Tokyo-based Sahoda. “Once the gatekeepers can start doing their jobs properly, this could actually lead to an improvement in the industry.”

Thirty-two percent of 119 Japanese pension funds wanted to add alternative investments in the current fiscal year, a survey in April 2011 by JPMorgan Chase & Co. (JPM)’s Tokyo-based asset management unit showed.

“If the story coming out is true, then it’s a massive failure of due diligence,” said Rogers Investment’s Kennedy. “However, hedge funds play a critical role in modern portfolios and we must be careful to not condemn all hedge funds out of hand.”

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

To contact the editor responsible for this story: Andreea Papuc at apapuc1@bloomberg.net

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