Passive investing may not yet have achieved the level of popularity it has in the US or UK, but it is definitely on the rise in Japan. In light of changes in the government pension system and in the accounting standards applied to pension funds, Japanese plan sponsors are taking a serious look at their asset allocation and investment structure. The principal trends resulting from this review include:
q a desire for greater exposure to equities;
q increased hiring of specialist managers; and,
q greater use of structured investment techniques (including passive and enhanced indexation).
At the end of 1998, Japan ranked eighth in the use of passive management for equity assets, with just 6%, a considerable way behind the likes of the US, the UK and the Netherlands, but equally ahead of France and Germany1. Also in that survey, Japan occupied the same position for the use of specialist managers, with 15% of assets managed in specialist strategies, against 82% in the US, 27% in the UK, and 13% for Europe as a whole. Historically Japanese pension funds have shown a marked preference for peer group benchmarks. As funds break away from that mindset and consider more efficient strategic mixes, there is evidence of increasing sophistication in the approach of pension funds to investment issues.
There are a number of well-documented benefits ascribed to passive management. Of particular relevance to the Japanese market, indexation can be used to help control overall tactical risk, to help implement strategic asset shifts, and to control costs. This will most clearly affect manager structure, with increasing use of core-satellite approaches. By creating a core passive portfolio, Japanese pension funds can also build on specialist mandates that facilitate greater investment skill and widen manager choice in order to achieve their investment objectives.
A recent study by the Nomura Research Institute confirms these trends – a wide range of Japanese corporate funds were asked how they were planning to evolve their investment approach:
The predominant shift, particularly among the larger corporate plans, is towards implementing a specialist structure. Part of that move is likely to witness a greater allocation to passive management. The government-backed public pension plan is expected to make a similar move. Some projections have gone as far to suggest that up to 50% of its total assets will be invested passively within the next seven years. Beyond that, in years to come we may well see the Japanese market take on the concept of portable alpha, with passive strategies providing the core foundation around which high risk strategies are employed to generate high alpha.
While the growth of index assets may have peaked in the US and the UK, along with Europe, we can expect to see passive investing become ‘Big in Japan’. The biggest five managers of index assets, which handle more than 70% of total worldwide assets under passive management2, look to be well placed to benefit from this trend.
Eoin Murray, director, passive and quantitative product manager at Deutsche Asset Management in London
1 Watson Wyatt Global Asset Study G11 survey
2 P&I: Special Report on Indexing and ETFs, March 5, 2001