Changes are coming to the management of the world's largest pension fund. This is Japan's Government Pension Investment Fund, which at the end of 2013 had assets of about 1.24 trillion yen. ($1.2 Trillion US) For years, the GPIF has been one of the biggest holders of Japanese Government Bonds. Since the Japanese were big savers, Japan was able to internally finance most of the Japanese debt. Often this was given as the reason the yen was a safe haven currency.
Despite many years when government revenues were less than 50% of expenditures, and debt became inflated to 230% of the GDP, the yen bears were unsuccessful. This all changed with the election and the vision of PM Shinzo Abe. His policies, in part, have resulted in a 20% devaluation of the yen versus the USD. His forthcoming changes in the allocation of Japanese investments may result in shocking changes for the value of the yen, as well as their stocks and bonds.
The decisions for the new asset allocation will be made by Investment Committee of the GPIF. Last week the new committee appointments were made by Health Minister Norihisa Tamura. In addition, the committee size was reduced from ten to eight. Those remaining and the new members are Abe loyalists who will be implementing Abe's desire for less reliance on government bonds and more investments in riskier assets.
The eight members on this committee are going to become extremely popular, because their decisions are going to direct the re-investment of $1.2 Trillion. Portfolio adjustment of this size are rare. Certainly, there will be thousands of grifters willing to buy drinks, dinners and other favors for the committee members, in return for inside information from the last committee meeting. The reinvestment of a trillion is a big event.
There are multiple market issues that need to be addressed. What will be the pace of the reallocation from Japanese Government Bonds (NYSEARCA:JGBS) to other assets? Will this occur only as existing debt matures, or will the pace be much faster? What percentage of the funds will remain in bonds, and how much will be switched into equities? Is the Japanese Equity [NKY:IND] market large enough to absorb an influx of funds without blowing values to outrageous heights?
For the forex traders, to what extent is the money currently invested in Japan going to be reinvested elsewhere, and invested in other currencies? Currently the 10-year yield of a Japanese bond is a mere .61%. This compares to a 10-year yield in Australia of almost 4%. To me this appears more attractive than buying Italian or Spanish 10-year debt at about a yield of 3.10%. In reinvesting this debt off shore, however, there is a currency risk. You need to sell the yen and buy the currency where you intend to invest. Do you like the A$ or the euro?
With risk, there is also the possibility for reward, and this might be the situation with the yen. Remember, the flow of funds into and out of currencies can be the most important fundamental influencing the value of one currency relative to another. More money gives a market momentum, and the early money is propelled by the later money.
Whatever the decisions of the GPIF advisers, there is another group of Japanese investors with an even larger sum of money, and they are likely to follow the lead of Tamura's new committee. In Japan, there are 43 life insurance companies. At the end of September 2013, these insurance companies owned 149.5 Trillion ¥ (Est. $1.4T) of JGBs. This represented 43% of their portfolios. Foreign securities were 17% of their investments, so they are familiar with the currency risks.
Currently the Bank of Japan has been buying bonds under their QE program designed to increase the yen supply and weaken the currency. Should the insurance companies and the GPIF both start selling their bond inventory, yields would turn higher as the BOJ would be unable absorb the supply of bonds then being offered. This situation would be chaotic and likely weaken the yen.
The Investment Committee of the GPIF, if it behaves like other government agencies, will dither and deliberate. Eventually the move to other debt, rather than JGBs, and equities both foreign and domestic seems quite probable. When that happens there will be selling pressure on the yen.
As we noted in the latest COT report there was big buying in the yen, as the shorts covered. The USD lost a little over 250 pips and about 20K contracts of yen shorts were liquidated. It looks like the weak short in the yen are now out. We continue to look for USD weakness versus the yen to buy the USDJPY (FXY, UUP, UDN). Our initial target is around 107.50. As always with the yen, patience is required.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.