Published in the Nikkei Asian Review 12/3/2015
Japanese financial slang for something of disproportionate size to its surroundings is “a whale in a pond.” The drastic change in asset allocation at the Yen 120 trillion GPIF (Government Pension Investment Fund) is creating a mini-version of the phenomenon – akin, perhaps, to a 250 kg sumo wrestler lowering his bulk into a hot spring bath.
Unusually the “water-level” of the Japanese stock market has risen this year without much participation by foreign investors. The decision by the GPIF, the world’s largest pension fund, to raise its exposure to domestic equities from 12% to 25% is at least partly responsible. And after the “yokozuna” (Grand Champion) comes a group of less formidable, but still chunky grapplers, such as funds related to the Post Office and the Civil Servants’ Federation.
As with many of the initiatives associated with Prime Minister Shinzo Abe – from the refusal to pay ransom to ISIS hostage-takers to the introduction of aggressively reflationary monetary policy – the pushback from political opponents and media critics has been intense.
Not just from opponents, either. Health and Welfare Minister Yasuhisa Shiozaki was handpicked by the prime minister in order to manage the reform of the GPIF, which is long overdue. Instead, the minister has become embroiled in a messy and increasingly bitter argument with cabinet colleagues and the new GPIF chief – formerly a London-based private equity executive – who was appointed before his arrival.
The dispute appears to be technical, but actually concerns key questions of control and accountability. Japanese bureaucracies, like others elsewhere, react to the prospect of transparency like a vampire reacts to the coming of daylight. The old GPIF, like the old Bank of Japan, manufactured its own murk-enshrouded remit and turned a blind eye to global best practice on the grounds that Japanese conditions were unique. The Abe administration is attempting to put an end to such thinking while hold-outs in both institutions hark back to the “independence” that was too often a fig-leaf for ineptitude and inertia.
BUFFETT SPEAKS
What about the common criticism – voiced, for example, by Nobuaki Koga, head of the Rengo federation of labour unions – that the Abe administration is irresponsibly gambling with pensioners’ money? The reality is quite the opposite. What would be irresponsibly risky would be to maintain the GPIF’s former exposure of 60% to Japanese government bonds.
In his recent annual report, Warren Buffett stated ”stock prices will always be far more volatile than cash-equivalent holdings. Over the long-term however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time… Volatility is far from synonymous with risk.”
By “currency-denominated instruments” Buffett means fixed return assets such as US government bonds. The case is even stronger for Japanese bonds where yields are approaching vanishing point. In contrast, Japanese equities have been in an extraordinarily long and severe bear market since the bursting of the bubble economy in 1990, but now valuations are unexceptionable on both historical and international comparisons. The experience of the past 25 years will not be repeated. The GPIF’s new asset allocation may look drastic, but is merely in line with the playbook of similar institutions overseas.
The Sage of Omaha’s advice could be taken further. Japan is the world’s largest net creditor, but has managed its financial portfolio in a far from optimal way, much to the detriment of its long-term prosperity. Rather than keeping its trillion dollar hoard of foreign exchange reserves in low-return and – in Buffett’s words – “risky” US treasuries, the Japanese government should consider establishing a sovereign wealth fund to diversify into real assets, such as US infrastructure, real estate and equities.
THE NEW VIGILANTES
One of the unfortunate results of the extraordinary thirty five year global bull market in government bonds has been to increase the authority of bond market investors, analysts and ratings agencies – the so-called “vigilantes” that have validated damaging austerity policies all over the world since the financial crisis of 2008. What bond markets like most of all are recessions and what they fear are economic booms. In current conditions, pleasing investors in government bonds should be the last thing on any policy maker’s mind.
For Japan in particular, creating an equity culture must mean downsizing the bond culture which has become so inordinately powerful. A bond market strategist even sat on the BoJ’s policy board; needless to say, no equity market specialist has ever been appointed. Horror stories of bond market collapse have been regularly used to justify tax increases and spending cuts, with last April’s recession-inducing hike in the consumption tax being the latest example. Meanwhile one of the longest and ugliest equity bear markets in history has been shrugged off as a mere inconvenience.
If Japanese reflation is to succeed, the tables must be turned. Prime Minister Abe’s personal appearances at the New York and Tokyo stock exchanges suggest he understands that well enough. From now on it will be the equity market vigilantes who judge economic policy.
With some help, perhaps, from a conga-line of sumo wrestlers.