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A turning point in Japanese pensions

Nov 05, 2008

Tokyo, November 5, 2008: JPMorgan Asset Management (Japan) Ltd. today announced the results of a survey conducted this year to find out more about Japanese pensions' current investment attitudes and future trends.  The report's findings clearly indicate that Japanese pensions are facing a critical turning point in their asset management style, which can be described as "diversification" following the rapid change of market environment after the sub-prime shock.

Key findings in this report are as follows:

Overview of the portfolio and major challenges

• Japanese pensions are facing up to a critical turning point for diversification, aiming for more investment diversification.
• Among asset classes, Japanese pensions plan to reduce equity, especially domestic equity, and shift allocation into alternative assets.

Findings from the survey indicate that Japanese pensions are facing up to a critical turning point in terms of diversification, aiming for more investment diversification. This trend will heavily impact both traditional and alternative assets.

Above all, the possibility of a large-scale asset allocation shift is indicated, which may determine the future direction of pension asset management in Japan. To be specific, a significant portion of pension respondents indicated that they will reduce their equity allocation, especially domestic equity (69.7% of all respondents), and shift into alternative assets (51.5%). Regarding foreign equity allocation plans, the percentage of respondents who will reduce their allocation (33.3%) versus those who intend to increase their allocation (27.3%) is nearly balanced, while the number of respondents who will decrease the allocation is predominant for domestic equity. This indicates a possible allocation shift from domestic equity into foreign equity. (Graph 1)

Graph 1: Planning to increase/decrease

Full-scale introduction and increased variety of alternative investment

• In Japan, absolute return products show the highest participation rate, while the introduction of private equity and real estate-related investments are lagging the US and Europe.
• While alternative investments are currently concentrated in the absolute return segment, there is some sign of a full-scale introduction of other alternative investments as a substitute for equity, such as private equity, real estate-related, infrastructure and commodity-related investments.

The survey findings suggest possible large changes in the allocation within alternative asset classes, to which many pensions are also expected to increase their allocation. So far, alternative investments in Japan have been concentrated in absolute return products*, which are mainly introduced as a substitute for bonds. The participation rate for absolute return in Japan is almost 80%, which is much higher than the 59% of the US and 42% of Europe. On the other hand, contrary to the experience in the US and Europe, other alternative investments, such as private equity (25.7%) and real estate-related (43.2%) have not become commonly accepted yet. (Graph 2)

*Fund of hedge funds, equity market neutral, equity long-short, etc.

Graph 2: Alternative investment participation rate in Japan, US and Europe

Note: US numbers are from “Next Generation Alternative Investing”, JPMAM. European numbers are from the Alternative Asset Survey 2007 ”Are alternatives mainstream?”, JPMAM.

However, the combined proportion of pensions who have already invested in these asset classes and those who are planning to invest is much higher, reaching over 50% for both private equity and real estate-related, and over 40% for infrastructure. (Graph 3) From now on, alternative investments which are expected to take on the role of a substitute for equity are expected to expand and the diversification of alternative investments is likely to develop.

Graph 3: Alternative investment allocation weight

Hidenori Suzuki, head of the Strategic Investment Advisory Group at JPMorgan Asset Management Japan, who spearheaded this survey, said, "The background to these new trends is that the change of market environment after the US sub-prime shock and possible changes to the domestic pension system's environment, such as accounting standards revisions, have forced Japanese pension funds to develop stricter risk management. Another driver of the current trend is the fact that the focus of pension funds has shifted from the risk of interest rate hikes that is associated with economic recovery to the risk of equity price falls. As a result, Japanese pension funds are now facing up to a critical turning point. Going forward, diversification and reduction of equity risk will be the main themes for Japanese pension funds and a new tide of investment diversification is expected in both traditional and alternative assets, by way of an overhaul of equity investments and the full-scale introduction of alternatives substituting for equity."

This survey was conducted from June to early October 2008, to which a total of 74 Japanese pension funds responded, including 48 defined benefit corporate pensions, 17 corporate employee's pension funds and 9 others.

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JPMorgan Asset Management group
JPMorgan Asset Management group is part of JPMorgan Chase & Co. and is a global asset management leader providing world-class investment solutions to clients. With US$1,185 billion in assets under management (as at 30 June 2008) and offices in 40 locations around the world, JPMorgan Asset Management offers global coverage with a strong local market presence, and leadership positions in most asset classes.

JPMorgan Chase & Co. (NYSE: JPM) is a leading global financial services firm with assets of $2.0 trillion and operations in more than 60 countries. The firm is a leader in investment banking, financial services for consumers, small business and commercial banking, financial transaction processing, asset management, and private equity. A component of the Dow Jones Industrial Average, JPMorgan Chase serves millions of consumers in the United States and many of the world’s most prominent corporate, institutional and government clients under its J.P. Morgan and Chase brands. Information about the firm is available at www.jpmorganchase.com.