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Japan pension whale GPIF in China bond quandary: backlash or gains?

FTSE Russel's embrace of the high-yielding debt forces the fund to decide

The 10-year yield of Chinese government bond tops 3%, higher than returns in developed countries.   © Reuters

TOKYO -- Japan's Government Pension Investment Fund faces the tricky question of whether to adopt Chinese sovereign debt into its portfolio, a move that would lead to healthy returns but risks sparking outrage over financially backing an alleged human rights abuser.

The issue gained steam Monday when the British index provider FTSE Russell decided to include Chinese government bonds in its benchmark FTSE World Government Bond Index (WGBI). The incorporation will be phased in over a three-year period starting at the end of October.

The GPIF, one of the world's largest institutional investors, passively managed roughly 16 trillion yen ($145.8 billion) using the WGBI at the end of March 2020. The GPIF is not required to adhere to the index, but without Chinese government bonds, the portfolio risks underperforming the market average.

Globally, $2.5 trillion in assets under management are linked to the WGBI, data from HSBC shows. Chinese government bonds will eventually attain a weight of 5.25% in the index. That would translate to about $130 billion worth of the debt being purchased.

The 10-year yield of Chinese government bond tops 3%, higher than yields in developed countries that have maintained low-rate policies as part of the coronavirus response, making the instruments an attractive option.

The percentage of foreigners owning Chinese government bonds stands at 8.5%, more than doubling in three years. China's bond market is the second largest in the world behind the U.S., another factor that makes it difficult for the GPIF to pass up the bonds. 

The GPIF, which oversees about 180 trillion yen in assets, currently has zero exposure to yuan-denominated bonds. There are other bond indexes that have included Chinese government bonds, but the GPIF excludes the sovereign debt from its asset management, citing liquidity issues and restrictions on foreign investors.

Regarding the WGBI, "it will take time before [Chinese government bonds] are included in the index, and we will consider a response after an internal discussion," a source at the GPIF said.

Given the cautious view held by the Japanese government, it is unclear if the GPIF will buy Chinese government bonds once the WGBI starts incorporating the debt with the index.

Wariness toward China has affected investments by U.S. and European pension funds. Last year, the White House under former U.S. President Donald Trump pressured the Federal Retirement Thrift Investment Board, which manages pensions for federal employees, to suspend plans to incorporate Chinese equities into its portfolio.

That same year, Denmark's AkademikerPension decided to divest Chinese stocks and bonds in part to protest reported human rights abuses of the minority Muslim Uyghur population.

A growing number of institutional investors are taking environmental, social and corporate governance themes -- or ESG -- into account when managing bond portfolios. Asset managers in the Americas and Europe will likely be split when it comes to investing in Chinese government bonds.

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