World’s Biggest Pension Fund Doubts 2% Inflation for Japan

Japan’s central bank probably promised too much when it set a goal of lifting inflation to 2 percent within two years, according to Takahiro Mitani, president of the country’s public pension fund.

History is against the Bank of Japan as it undertakes unprecedented asset purchases in pursuit of a pledge to overcome 15 years of deflation, Mitani, the 64-year-old head of the 112 trillion yen ($1.14 trillion) Government Pension Investment Fund, said in a Tokyo interview June 21. The world’s biggest manager of retirement savings, which said on June 7 that it’s cutting local bond holdings to buy more stocks and foreign securities, plans to leave its asset allocations at the new levels until at least March 2015, he said.

The BOJ has pledged to double the monetary base by the end of next year while Prime Minister Shinzo Abe is promising public spending, tax reform and freer markets to reinvigorate Japan’s economy. It’s been 21 years since annual inflation in Japan exceeded 2 percent, according to the World Bank.

“It’s going to be very difficult,” Mitani said. “The BOJ think that if they say they will take bold measures to bring about inflation, then inflation expectations will rise and as a result prices will rise. But reality isn’t that smooth. Even in the bubble, inflation was only about 1 percent.”

In the last five years of the 1980s, when Japan’s gross domestic product climbed from $1.3 trillion to $3 trillion and the Nikkei 225 Stock Average peaked at almost 39,000, the monthly readings for inflation averaged 1.2 percent, according to data compiled by Bloomberg. In the decade to April 2013, the average has been minus-0.1 percent, the data show.

Harsh Outlook

Mitani said in February that if Abe and the BOJ are successful then a 67 percent allocation for local bonds would look “harsh.” The fund cut its target holding for local government bonds to 60 percent from 67 percent, while the proportion of foreign and local shares will rise to 12 percent each, from 9 percent and 11 percent respectively. The allocations announced this month are close to what the fund already holds, he said.

The central bank can add to its unprecedented monetary easing announced two months ago should economic conditions change significantly, BOJ Governor Haruhiko Kuroda told lawmakers last week. The bank is buying 7.5 trillion yen of bonds a month, which Kuroda said in April will mean the bank is buying the equivalent of 70 percent of government bond issuance, along with more risk assets like real estate investment trusts and exchange-traded funds.

Another Angle

“I don’t know what they will do next,” Mitani said. “If they do need another hand, I don’t think they can buy much more bonds. So they’ll have to come at things from another angle. Kuroda-san said something about J-Reits and they have increased up to upper limit but they could expand that, so maybe they could buy other things.”

The BOJ’s policy is to boost its holdings of exchange-traded funds and Japan real-estate investment trusts by about 1 trillion yen and about 30 billion yen per year respectively. That contrasts with about 50 trillion yen for purchases of Japanese government bonds.

Benchmark 10-year government bond yields have swung from an all-time low of 0.315 percent to as much as 1 percent since the BOJ announced its plan in April. The yield rose 1.5 basis points to 0.88 percent at 7:08 p.m. in Tokyo today.

Yields will “calm down below 1 percent,” Mitani said. “I don’t think many in the market think it’ll be 2 percent in two years. If the BOJ start reducing bond buying, then supply and demand may change so over the long-term, it’s hard to say. Of course if inflation rises, then it may change. I think most people in the market don’t know whether to be concerned about bond supply and demand or inflation.”

Stock Correction

Stocks surged after the BOJ’s April announcement, taking gains since elections were announced that brought Abe to power to as much as 77 percent before the rise in bond yields triggered a correction that began on May 23. The Topix index, the country’s broadest equity measure, closed at 1,089.64 today, almost 15 percent below its May 22 high.

“The markets are very demanding,” Mitani said. Even if the BOJ increases its stimulus efforts “just a little bit, it’s not as good as they want, they will ask for more. I don’t think the BOJ have to keep dealing with what the market wants at every turn. I don’t know what hand they have. I’d like them to think about it.”

The GPIF will release results and more details on its holdings in July, Mitani said. The fund didn’t alter the structure of its holdings during the 2008 financial crisis or in response to the 2011 earthquake and nuclear disaster. The reweighting of its portfolio wasn’t a response purely to the change in policy by the BOJ or Abe, Mitani said.

Historical Analysis

“Some people think that we changed our core portfolio just because of market changes,” Mitani said. “But it’s not like that. We decided to look back over past data and recalculate things. That was how we came to our new portfolio decision. For instance, we use data looking back to 1973.”

The shift toward higher-yielding assets comes as the manager prepares to fund retirements in the world’s oldest population. Stocks extended their declines after Abe said on June 6 that a legislative campaign to loosen rules on businesses, the “third arrow” of his economic plan, won’t begin until after upper house elections next month.

“Maybe some have been disappointed by the economic growth strategies they have seen from Japan so far,” Mitani said. “When people tell me they are disappointed, I tell them that there is the elections, so once the elections are over, we may see an Arrow 3.5. Abe has basically said that too.”

Tokyo Poll

The ruling Liberal Democratic Party and its coalition partner won nearly two thirds of the seats in a weekend Tokyo assembly poll, increasing optimism for the party’s prospects in the national upper house election on July 21. Victory for the LDP in the upper chamber would end the hung parliament that has hampered decision-making.

The fund returned 3.3 percent in the three quarters though December, according to its latest results. Japanese bonds returned 1.48 percent, local stocks posted a 1.63 percent profit and foreign bonds and stocks returned 10.3 percent, according to their statement.

GPIF is the biggest pension fund in the world by assets, followed by Norway’s government pension fund, according to the Towers Watson Global 300 survey in August.

Review Ordered

The Ministry of Health, Labor and Welfare, which oversees public pensions, demanded GPIF re-examine its portfolio structure after a recommendation by the Board of Audit Japan, an organization independent of the government in charge of auditing state accounts and public bodies.

GPIF should frequently review the efficiency and security of its asset allocation, the board said in October last year, according to a statement released with the reallocation announcement on June 7. The fund has a range of plus or minus 8 percent for its allocation to JGBs, 6 percent for local stocks, and 5 percent for foreign assets.

“If there are big changes to the market, then we must discuss whether we should make changes,” Mitani said. “We just made a new portfolio so if we can, we don’t want to touch it. We can’t change our core portfolio that often, or else it’s not really a core, is it?”