TOKYO -- The Bank of Japan's zero interest rate policy is forcing Japan's Government Pension Investment Fund to take on more risk via an increased portfolio allocation to stocks, as near-zero yields have made Japanese government bonds nonviable as core holdings.
The GPIF aims to secure returns equivalent to the rate of wage growth plus 1.7 percentage points in order to make good on payouts. The fund overhauled its base asset allocation policy in October 2014 amid the reflation push by the government. The rationale behind the change is that a portfolio heavily biased toward JGBs would fall short of the yield target once the economy sheds deflationary pressures.
The new policy sets allocation goals of 35% for domestic bonds, 25% for domestic equities, 15% for foreign bonds and 25% for overseas stocks. Before the realignment, 60% was the desired proportion for domestic bonds.
The heavier focus on equities resulted in an investment profit of more than 10 trillion yen ($90 billion) for October-December 2016, a quarterly record due to gains in Japanese and foreign stocks. Cumulative income after the portfolio overhaul has climbed to 11.7 trillion yen.
The solid returns are good news, but a concerning shift has been occurring in the fund's domestic bond portfolio. Allocations on those low-risk assets has fallen below the 35% target and hit a record low of 33.26% at the end of last year. Funds from redemptions of its Japanese government bond-holdings have been redirected toward short-term assets, lifting their share to 6.46%, the second-highest level on record.
This scenario is playing out because the interest rate outlook adopted in 2014 widely missed its mark. Yields not only failed to increase, but the BOJ's monetary easing policy drove long-term interest rates into negative territory at one point. Long rates are currently hovering near zero. Since JGBs will generate hardly any interest income under such a rate environment, it is "difficult to justify JGB buying," a person close to the GPIF noted.
Dividends and interest income used to make up two-thirds of the GPIF's cumulative earnings. If JGBs with relatively higher returns continue to be redeemed, the income from JGBs will shrink further. This would make the GPIF's portfolio even more susceptible to stock market fluctuations than it already is in the foreseeable future.