Investor Universe Japan: Waking the sleeping giant

It is inevitable that Japanese institutions will move into global real estate. But it will take time and poses many challenges, writes Sharon Hayes

Japan, the world’s third-largest pension market, is poised to undergo a dramatic rebalancing of its investment portfolios. Japanese pension funds are unshackling themselves from a long tradition of investing only in bonds and equities.

Collectively, they owned US$2.63trn (€2.36trn) in assets in 2015, according to Willis Towers Watsons. Experts told IPE Real Estate that some proceeds from maturing bonds will be reallocated to alternatives – real estate, private equity and infrastructure.

Japan’s Government Pension Investment Fund (GPIF), the world’s largest pension fund, has made the first move into alternative assets. As of 30 September 2015, the $1.14trn GPIF had about 53% of its assets in bonds.

Charlie Haase, managing director of overseas business development at Tokyu Land Corporation, says the Japanese government is strongly encouraging pension funds to explore alternative investment classes.

“Relying on returns from bonds is a very difficult investment strategy in the face of the diminishing number of workers and a growing number of retirees,” says Haase.

At the end of January, the Bank of Japan made the shock decision to adopt negative interest rates in a bid to boost its economy. Yukihiko Ito, managing director of Asterisk, a Tokyo-based placement agency, says the move might accelerate a rebalancing among Japanese investors. 

Japan Post Bank, the world’s largest deposit holder, recently announced a new division for real estate as part of its plan to reduce its exposure to Japanese government bonds and increase investment overseas.

Ito says it can be seen as indirect support by the government to rebalance and reform GPIF’s investments.

Hideyuki Sato, managing director, US project department, at Tokyu Land, explains that pension funds have survived in the past partly through government subsidies and by raising employee contributions.

The timing for rebalancing is opportune. Jun Muto, head of the capital advisers team at CBRE Japan, says: “Yield has diminished and the bulk of fixed-income products issued before and after the GFC [global financial crisis] periods are reaching maturity in the next few years. Investors are looking for stable income products to reallocate.”

Ito says: “Until five years ago, most portfolios consisted of domestic bonds. Then, government reforms started and pension funds were allowed to invest in foreign government bonds and offshore equities.”

Pension funds understand they need diversified portfolios, he says, because bonds and equities will not generate sufficiently stable, long-term income to meet liabilities.

Ito says that they now realise long-dated assets, such as infrastructure, real estate and private equity, can provide growth and income in step with inflation

Japanese public pension funds are generally expected to allocate up to 5% of funds under management to alternatives, says Ito. 

Therefore, with the four largest funds holding assets totalling $1.42trn, there could be as much as $72bn available for alternatives. Ito estimates that possibly 40-60% of that amount could go to real estate – split between domestic and global real estate.

Furthermore, based on GPIF’s equities allocation pattern, he believes that offshore real estate could take up to half of the property allocation.

Hideyuki Sato believes that the large Japanese pension funds will allocate at least $10bn – or 1% of their assets – to property.

Since 2014, Haase says, GIPF has invested in a $2.5bn infrastructure investment programme jointly with the Ontario Municipal Employees Retirement System (OMERS) and the Development Bank of Japan. The Japan Times reported in December that GPIF’s investment in infrastructure rose to about ¥70bn (€5.5bn).

“GPIF is such a giant, once it makes a decision to go into infrastructure investment the others, especially the large ones, will follow,” says Sato.

He also notes the significance in GPIF appointing Horimichi Mizuno, a former partner at Coller Capital in London, to a newly created position of CIO. This signals a changing of the guard in the ultra-conservative world of Japanese pension funds.

Japan’s three other top pension funds have adopted GPIF’s portfolio model. The Pension Fund Association for Local Government Officials (Chikyoren), and the Federation of National Public Service Personnel Mutual Aid Service (KKR) – have issued real estate RFPs.

Haase says corporate Japan’s disastrous experience in overseas real estate investment in the 1980s left an indelible scar. “Pension fund investment managers remember the bubble era and the problems well. The guys [we talk to] were younger at the time, now they are older and in decision-making positions.”

Muto says: “Three or four years ago when we talked to investors about real estate as an asset class, they wouldn’t even listen to us. That has dramatically changed with the BOJ’s inflation targeting policy.”

Most agree that Japanese pension funds face a formidable learning curve to get acquainted with alternatives. Currently, direct real estate is not part of their investment portfolios.

Their first brush with real estate has been with Japanese real estate investment trusts (J-REITs). They started investing in them at the turn of the decade, and have generally experienced strong returns.

Pension funds rely on consultants and trust banks for advice, but they themselves have little or no knowledge of real estate because it has not been a topic of discussion until now.

CBRE, for example, has received unsolicited calls from pension fund gatekeepers for research material on global real estate. “We even have small corporate pension funds calling us on our switchboard asking for research material,” says Muto.

Japan also has thousands of small corporate pension funds. Some 80% are insolvent and expected to be merged and absorbed by the Pension Funds Association (PFA), which manages ¥10trn in assets on behalf of corporate pension funds.

Haase adds: “Japanese pension funds are conscious of the fact that the amount of money they have to put out could affect the market.

“They will take slow and deliberate decisions because they are very aware of the impact they are likely to have on local markets with the size of their investments.” 

Because they do not have in-house investment professionals, Japanese pension funds are expected to initially invest through global asset managers. They are also more likely to seek open-ended core funds, for assets in Europe and the US.

But scepticism remains as to how fast the Japanese will act. 

“I have been in Japan for eight years and they have been talking about allocating money to alternatives all that time,” says one expatriate property executive. “The risk for them is that they may be too slow and too late. Prices of assets around the world are probably too high now for them to start their offshore investment programme.”

Not so, says Haase. “I worked for a public pension fund, and we were similarly slow in making decisions. But we were still able to get into the market.”

Okubo says CBRE’s view is that Japanese investors are getting more interested in deploying capital abroad.

The most optimistic observers, like Ito, believe Japanese funds could strike their first offshore deals in 2016. 

Others believe the earliest they will commit to offshore investments will be 2017, or even 2018.