LP focus: Japan's pension pathway

As Japan watchers will know, change in the world’s third-largest economy is sometimes akin to watching moss grow. For those in private equity, plans for large-scale investment by the nation’s institutional investors have been slow to gain speed.

Yet, developments over the last 12 months have been encouraging. In September, Japan Post Group’s insurance unit, which manages around $800 billion in assets, announced it had launched an alternatives division. The move mirrored sister division Japan Post Bank’s establishment of a private equity division a year prior and means the postal savings behemoth is taking alternatives seriously.

Then there’s Chikyoren, the $185 billion Pension Fund Association for Local Government Officials, which in July issued requests for proposals for private equity, a year after releasing similar requests for real estate and infrastructure. Chikyoren’s target allocation to alternatives, including private equity, infrastructure and real estate, is up to 5 percent.

“There’s a real change coming to Japan, in mindset, in opportunity and in energy,” says Mounir Guen, chief executive at placement advisor MVision. Domestic investors have understood the “fantastic value” that Japan provides and are keen to gain exposure to their country, he says.

Market participants are particularly excited about two sources of LP capital, one of which is the nation’s corporate pension funds. While pension giant GPIF has been slow to act – just 0.07 percent of the fund’s roughly $1.4 trillion portfolio was invested in alternatives as of the end of last year – corporate pensions have been steaming ahead, shifting capital to alternatives from traditional assets.

According to JPMorgan Asset Management, which surveyed more than 120 Japanese corporate pensions last year, around 70 percent of defined benefit pensions were invested in alternatives as of the end of March 2016 and among these, the average allocation to alternatives was almost 19 percent, second only to domestic bonds.

Condiment maker Kewpie’s corporate pension fund has a 10 percent allocation to private debt and private equity and has been investing in private equity since 2008, according to Kosuke Okimori, the pension’s executive director of investment. He says Kewpie reduced its exposure to public equities after the collapse of Lehman Brothers. It splits its PE fund commitments roughly evenly between Japan-focused and non-Japan focused funds. 

Japanese LPs ramping up commitments to domestic private equity funds makes sense given the low interest rate environment, according to Guen, who says the country is overlooked by foreign investors in the marketplace.

“They still haven’t gotten their heads around the opportunity and the potential level,” he says, adding that Japanese private equity funds are typically between 80 percent to 100 percent domestically funded.

The other source of LP capital market participants are excited about is the nation’s regional banks, of which there are 64. Among them they hold around 248 trillion yen ($2.2 trillion; €2 trillion) in deposits and make their money from holding deposits at a rate of around 0.01 percent and making loans at around 1 percent.

With this spread so narrow, they’re searching for different ways to make better returns. Investment professionals at the regional banks have started spending the majority of their day until 3pm watching the public markets, and after that spending their time getting up to speed on private market investments, sources tell Private Equity International.

Average ticket sizes from corporate pensions and regional banks aren’t reaching dizzying heights – individual commitments may range from between $5 million to $10 million. But with institutions committing to as many as 10 GPs per year, the total amount of capital from these new investors has excited local private equity firms on the fundraising trail.

Yet, general partners raising Japan-focused funds shouldn’t succumb to style or size drift amid the influx of capital, some warn. Tuck Furuya, a partner at placement agent and secondaries advisory firm Ark Totan Alternative, says that GPs should keep a level head in the face of voracious appetites from new domestic LPs.

“All these fresh investors are coming in, partially because they like your performance but mostly because they’re running out of options to invest their money,” Furuya says. With abysmal returns in the interest rate market, such investors naturally find private equity attractive, he adds.

Japanese GPs whose previous fundraise was around the couple of hundred million dollar mark and are now seeking to double or triple that amount should proceed with extreme caution, according to Furuya.

“Is that a change in investment strategy? You guys were focused on small-cap, now you’re focused on mid-cap? That requires a different skillset,” he says. How firms will tackle deploying three times more money without increasing their investment professional headcount, for example, is a worrying issue and GPs would do well to exercise discipline, he adds.

While actual moves to deploy capital into alternatives by GPIF and Japan Post Group – which between them have more than $3 trillion in assets – is seen by many as glacial, it’s clear other LPs are ahead of the curve.

One institution that doesn’t need to be convinced of Japan’s private equity potential is the Development Bank of Japan. Nearly half of the wholly government-owned organisation’s asset management arm’s $10 billion portfolio is invested in private equity, and it allocates around a quarter of its portfolio to Japanese GPs. As for strategies, the institution is interested in buyout, growth, mezzanine, distressed and secondaries funds.

DBJ AM’s activity hints at an approach that may be around the corner in the Japanese LP market. Secondaries and funds of funds will prove the most popular routes to access private equity, according to the JPMorgan survey, with the pensions surveyed identifying three mandates of each strategy to be allocated to across 2016 and 2017.

Amid what seems like a buoyant fundraising market for domestic GPs, Japan’s private equity managers still have a lot on their shoulders. For Furuya, the hope is that private equity funds who raised capital last year or who are on the trail this year will make good use of their money.

“Hopefully it will be a rewarding experience for the new LPs and it will create a bigger market in Japan,” he says. “Hopefully five years down the road all these investors will say their investments were worth it.”