http://www.zerohedge.com/news/2013-06-03/problems-japans-plan-b-government-pension-investment-funds-house-bonds
Submitted by Tyler Durden on 06/03/2013 22:41 -0400
Submitted by Tyler Durden on 06/03/2013 19:58 -0400
The Problems With Japan's "Plan (jg)B": The Government Pension Investment Fund's "House Of Bonds"
“So long as public funds ultimately are governed by the government, which is controlled by representatives of the general public, risk tolerance is subject to the general public’s risk tolerance, and the general public’s risk tolerance is not necessarily high. If and when the stock market collapses and performance goes negative for some time, people, the media and politicians will complain loudly... Who exactly is responsible for the future payment of benefits? Those who make the promise today may not be the people to actually deliver on the promise in future decades. It is much easier to make a promise that somebody else is supposed to carry out. Here the future generation is not in a position to sign the contract at all. This is the critical agency problem.”
- Yuji Kage, former CIO, Pension Fund Association
Now that the BOJ's "interventionalism" in the capital markets is increasingly losing steam, as the soaring realized volatility in equity and bond markets squarely puts into question its credibility and its ability to enforce its core mandate (which, according to the Bank of Japan Act "states that the Bank's monetary policy should be aimed at achieving price stability,thereby contributing to the sound development of the national economy) Japan is left with one wildcard: the Government Pension Investment Fund (GPIF), which as of December 31 held some ¥111.9 trillion in assets, of which ¥67.3 trillion, or 60.1% in Japanese Government Bonds. Perhaps more importantly, the GPIF also held "just" ¥14.5 trillion in domestic stocks, or 12.9% of total, far less than the minimum allocation to bonds (current floor of 59%).
What the GPIF has going for it is that with a total asset size of just about $1.1 trillion, it is the largest government pension fund in the world. It is almost equal to the size of Korea's economy, has nearly six times as much assets under management as CALPERS, the biggest US pension fund, and nearly four times as much as Europe's largest pension plan, Stichting Pensioenfonds ABP of the Netherlands. Which means that the mere whisper of capital reallocation sends assorted asset classes scrambling.
It is this massive potential buying dry powder that has led to numerous hints in the press (first in Bloomberg in February, then in Reuters last week, and then in the Japanese Nikkei this morning all of which have been intended to serve as a - brief - risk-on catalyst) that a capital reallocation in the GPIF is imminent to allow for much more domestic equity buying, now that the threat of the BOJ's open-ended QE is barely sufficient to avoid a bear market crash in the Nikkei in under two weeks.
There are some problems, however.
The first of which, is that GPIF appears to be a "jack of all trades" when it comes to its potential utility. It was only in March that HSBC wrote in "Japan's trillion dollar bond rotation" that "there is clearly a bias to shift more public funds into international markets", and that "Crucially, the GPIF is conducting a review to accelerate divestments in domestic bonds in favour of EM." Wait, reallocation from domestic bonds into international markets, and specifically bonds? Oh yes, that's because back then Europe needed backstopping and the mere threat of a Japanese carry trade tsunami was sufficient to send peripheral bond yields plunging to near record lows (despite Europe's imploding economy).
Fast forward to today, when we now learn that this mythical reallocation from domestic into international bonds has been put on hiatus (PIIGS yields plunging notwithstanding), and has been replaced by a new narrative - one which is suddenly the much more critical, and Abenomics preserving one: reinvesting out of domestic bonds and into domestic stocks, thus providing a backstop to the BOJ. Problem is, cry capital-reallocating wolf enough times, and soon someone will demand to see proof before taking you at your word.
This problem is compounded by another problem: as we wrote several years ago, in 2010, due to the demographic crunch of Japanese society, the GPIF became, for the first time ever, a net asset seller. This can be seen on the charts below.
Worst of all, and as can be very vividly seen on the charts below, not only has the GPIF been consistently leaking assets in the past four years, it has already been actively reallocating away from bonds: in fact, at 60.1% of total assets, the JGB holdings as of December 31 a % of total assets are the lowest they have been in decades (and just above the 59% threshold), while the allocation to domestic stocks has soared from 12.3% in Q3 to 14.5% in Q4: the highest in two years. Just how much dry powder does this pension fund really have before it literally bets the bank on the riskiest of all asset classes, and - in the off chance it bets incorrectly - dooms tens of millions of people to retirement in poverty? So the GPIF needs a reallocation program? Sounds to us like it needs to invest more into JGBs!
Total GPIF assets:
Relative GPIF assets:
So will the GPIF indeed scramble to reallocate into equities or is this merely the latest bluff in a long series of pseudo-political gambits? Here are some thoughts from HSBC on this issue:
Domestic equities might be an obvious target for the reallocation of assets, especially if the impressive rally in the Nikkei continues. But Japanese investors will be very reluctant to immediately pile into the local stock market. The asset bubble that burst more than 20 years ago left its mark. More than half of households’ USD15trn financial assets were kept in cash as of September 2012 and only 6% in equities, according to BoJ data. Other significant domestic holders of JGBs such as banks and pension funds will also be constrained to match liabilities and meet regulation requirements, implying bond investments, including overseas bonds, are more likely than equity investments.
Well that's great for Spanish bonds, but does nothing to help what may soon be the next great Japanese equity market bubble.
But wait, it gets worse.
As we have been showing over the past several weeks, suddenly a far bigger problem that has emerged for Japan is not what happens to the Nikkei, but whether it suffers an out of control collapse in its bond market, and sees a rapid, vicious and sharp sell off in the JGB complex as nearly happened on May 23, the day when the the Nikkei225 crashed. It is this that is the biggest structural threat to Abenomics, not whether or not Mrs. Watanabe will have generated enough money daytrading to avoid the 20% price surge in McDonalds.
So if indeed the GPIF does reallocate into equities (a very big if considering its multi-functional usage depending on the dry-powder threat need du jour), it will have to sell JGBs. Even more than it has sold so far. Which will then precipitate yet another rout in the JGB market, from where we go into such issues as the "VaR shock" we described two weeks ago (a topic the FT caught up with today), and all too real capital losses for Japanese banks who mark JGBs on a MTM basis.
Here is what HSBC had to say on this issue:
There is also an asymmetric risk to JGB yields in the very long term (ie beyond the next couple of years), making diversification compelling on a risk-adjusted basis. If official policies in Japan begin to bite and inflation rises on a more sustainable basis, this would place pressure on interest rates and materially reduce the value of JGBs held by banks. Yet, given the scale of such holdings, reducing exposure to JGBs would be difficult. Japanese financial institutions hold a substantial amount of JGBs. According to the BIS, Japanese banks hold 90% of their tier 1 capital in JGBs. Japan’s largest bank, Bank of Tokyo-Mitsubishi, has already acknowledged that reducing its USD485bn holdings of JGBs would be disruptive for the markets
Wait, what? Let's read more from the FT, shall we:
Nobuyuki Hirano, chief executive of Bank of Tokyo-Mitsubishi, admitted that the bank’s Y40tn ($485bn) holdings of Japanese government bonds were a major risk but said he was powerless to do much about it....The risk facing Japanese banks from their vast holdings of government bonds has been underlined by the chief executive of the country’s largest bank who said it would struggle to reduce its exposure.
Well that's not good: if the largest Japanese bank can't handle what may soon be concerted selling by one of the largest single holders of JGBs, who can? And what can be done then?
Oh, that's right: this is where Kuroda's plea to please not sell bonds, just to buy stocks comes into play. The problem is only the BOJ can come up with money out of thin air, for everyone else buying something, means selling something else first. So unfortunately unless the BOJ wishes to further increase its QE, which will be needed to absorb all the selling without a surge in yields (something Kyle Bass warned about last week), a move which however would further break the connection between bonds and inflation expectations, and further destabilize the equity, FX and bond markets.
So in short: Japan's Plan B is not only not a panacea, but it is a House of Bonds Cards that would not survive an even modest gust of wind, and an even more modest contemplation into its true internal dynamics. We would urge Messrs Abe and Kuroda to come up with a fall back plan to the fall back plan before it, once again, becomes too late.
Finally, for those who just can't get enough, we recommend the following piece by James Shinn for Institutional Investor which should explain all lingering questions about what really goes on at Japan's Plan B.
Of course if Abenomics fails , always have a back up plan....
http://www.zerohedge.com/news/2013-06-03/and-just-case-abenomics-fails
And Just In Case Abenomics Fails...
Whether the Japanese government guessed that the 150% annualized surge in the nominal price of their stocks, or 30% devaluation was unsustainable is questionable, but it seems that 'Plan B' is being created. As The Diplomat notes, finding itself in an increasingly complex and hostile security environment, Japan has taken the first steps towards developing a pre-emptive first-strike capability. This is a controversial move in a region that remains wary of a potential return to Japanese militarism.
...The ruling Liberal Democratic Party is compiling a new set of defense guidelines that would allow Japan’s armed forces, for the first time, to develop offensive capability, and to strike first if an attack appears imminent.Under Japan’s strictly pacifist constitution, the Self Defense Force is restricted to weaponry and tactics that are deemed defensive in nature. That means no bombers, no cruise or ballistic missiles, no armed drones - and no shooting until shot at.That could change under the new National Defense Program Guidelines, which are expected to be finished by year’s end."What they are basically saying is, ‘When a potential enemy has started attacking us, then we would start offensive operations to take out their missiles, as well as their missile bases,’"
Via J. Michael Cole of The Diplomat,
Finding itself in an increasingly complex and hostile security environment, Japan has taken the first steps towards developing a pre-emptive first-strike capability. This is a controversial move in a region that remains wary of a potential return to Japanese militarism.Just a few years ago, the idea that the Japan Self-Defense Forces (JSDF) would be given the ability to conduct operations that go beyond “self defense” would have sounded ludicrous, not to mention that offensive capabilities would have contravened a longstanding interpretation of Japan’s pacifist constitution.But North Korea’s continuing belligerence and pursuit of nuclear weapons and ballistic missiles, as well as China’s growing assertiveness and sovereignty claims, both appear to be changing Tokyo’s calculations. Another factor that is now making such ruminations possible is the U.S. “pivot” to Asia, which – though more in the concept stage than an actual policy – has manifested itself more tangibly through Washington’swillingness to reassess the role of JSDF in regional security. The budgetary constraints with which the U.S. military must now conjugate have made burden-sharing all but inevitable. One outcome is Washington is accepting a more muscular defense posture for Japan.Just a few months ago in the wake of North Korea’s third nuclear test, Japan’s defense chief, Itsunori Onodera, said in an interview withReuters that his country had “the right to develop the ability to make a pre-emptive strike against an imminent attack”, though he added that it had no plans to do so for the time being. Debate on such matters is not new, and usually occurs following a missile or nuclear test by the DPRK. But under Japanese Prime Minister Shinzo Abe, the government has shown itself much more willing to stretch interpretations of the constitution, if not to revise it altogether.Less than three months after Onodera’s interview, reportsemerged that Tokyo was working on a new defense policy framework that, at its core, made provisions for the development of a first-strike capability. Liberal Democratic Party (LDP) legislator and head of the LDP’s National Defense Division, Yasuhide Nakayama, made the recommendations and said that Pyongyang’s nuclear program and the Chinese intrusions in the disputed East China Sea waters had created an atmosphere where people in Japan felt “extreme anxiety about national security.”LDP officials maintain that pre-emptive strikes would only be carried out when an imminent attack on Japan from a specific site was confirmed. However this policy raises questions about the legality of pre-emptive action and the reliability of intelligence used to assess various scenarios (for example, pre-emption raises the risks and costs of miscalculation). Any move in that direction — which the National Defense Program Guideline, set to be released by the end of 2013, will make clearer — will require Tokyo to reassure its nervous neighbors about a military revival, or “resurgent chauvinist sentiment,” in Japan. Another important question to ask is whether a policy of pre-emption would extend to Japan’s security allies as well.There is little information on the type of capability the JSDF would seek to carry out such operations, though a ballistic and/or cruise missile component, perhaps something akin to Taiwan’s Hsiung Feng IIE land-attack cruise missile, is not unfeasible. Former Japanese defense minister and the second highest-ranking member in Abe’s LDP, Shigeru Ishiba – along with a growing number of Japanese politicians – seem to favor the development of long-range cruise missile technology.The new defense policy framework seems to focus primarily on North Korea and the threat that its missiles pose to Japan, South Korea and U.S. bases in the region. However, China also likely figures in their plans — including scenarios involving DF-15 and/or DF-16 ballistic missile attacks against U.S. bases in Okinawa. The risks involved in pre-emptive strikes in Chinese territory are much greater, however, especially considering China’s increasingly formidable air defense systems.Unless there is a dramatic shift in Tokyo or in Japan’s security environment, the current context seems highly conducive to the emergence of a more assertive JSDF. A pre-emptive capability is one component, and a highly controversial one at that. Whether it would increase or undermine Japan’s security remains to be seen, and will in part be contingent on how Tokyo handles the political repercussions of such a move.
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