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Japan's GPIF Changes Asset Allocation: So What?

Japan's Government Pension Investment Fund's (GPIF) decision Friday to change its asset allocation has received a lot of attention from investors all over the world. But few investors--even in Japan--really understand what this means. Unfortunately, there is a lot less than meets the eye.

The GPIF is the largest pension fund in the world and this is what has investors very excited. As of December 31, 2012, the latest figure available, GPIF assets totaled US$1,433 billion making GPIF an order of magnitude larger than even CalPERS, which checks in at a measly US$226 billion.

The GPIF has been debating a change in asset allocation for most of a year. GPIF's policy asset allocation had been unchanged since the GPIF took over fund management responsibilities from the old Ministry of Finance Trust Fund Bureau in 2004.

A lot of commentators have asserted that the government had pressured GPIF to adjust its asset allocation in order to support the Japanese equity market, which is in the throes of a painful correction. While it is true that Prime Minister Shinzo Abe did score some political points by demanding that GPIF change its asset allocation a few days ago, the decision had probably already been made at the time Abe made his comments.

Here are the facts:

The GPIF's policy asset allocation is set by an independent investment advisory board that makes recommendations to the Ministry of Health Labor and Welfare, which oversees the GPIF. The policy asset allocation is a target. The GPIF is allowed to diverge from the target allocation at its own discretion by quite a wide margin.

The changes in the GPIF's policy asset allocation announced Friday reflect the current asset allocation of the GPIF portfolio. Prior to Friday's announcement, the GPIF was supposed to have 67% plus or minus 8% in domestic bonds. As of December 31, 2012, GPIF was at 60.2% in domestic bonds--right at the bottom end of the allowable range. Setting the new policy asset allocation for domestic bonds at 60% plus or minus 8% simply reflects the GPIF portfolio as it stands today.

The other thing that is not well-understood is that the domestic bond allocation includes 10.2% of Fiscal Investment and Loans Program (FILP) bonds. These are an historical artifact from the days when the Japanese government used to use public pension funds as an off balance sheet piggy bank to fund public works projects such as the infamous bridges to nowhere. No new FILP bonds have been issued since 2007 but the ones already in the GPIF portfolio will be held until maturity.

That means that, contrary to market expectations, the GPIF is going to have to be a BUYER of JGBs as the FILP bonds mature in order to maintain the new policy asset allocation announced today.

Also, contrary to market expectations, GPIF will NOT be buying any more Japanese equities in the near future. What the new asset allocation does is to allow GPIF to let its profits run.

GPIF has been a steady seller into the recent rally because it was bumping up against its maximum asset allocation and had to rebalance its portfolio. Assuming the equity market finds its feet again after this correction, GPIF can let its equities run a bit further before selling.

Remember, more than 83% of GPIF's portfolio is managed passively and that isn't going to change. Only 3% of GPIF's total assets are being actively managed in the Japanese equity market. That's still a lot of money at the margin but it's not the tsunami of cash that most investors seem to think it is.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.