Pan-Asia Catalysts/Events, Quiddity Advisors

Travis Lundy

HK Type 4 license through Ballingal Investment Advisors Ltd. ("BIA" or "BIAL")

BACKGROUND
I have 20+yrs experience in Asia doing alternative strategies (i.e. non-delta1 non long-only) in fixed income, equity derivatives, and activist/catalyst/event-driven and long-short equity strategies with most of that time spent managing money. 

4 years in fixed income macro, 8 years running internal hedge fund and 4yrs investment banking at Citi in Japan, 3 years running an Asia multi-strat portfolio at a hedge fund, 4+yrs as an independent special situations analyst.

Pan-Asia Catalysts/Events

GPIF Policy Mix Changes Ride to Global Risk Rescue

Quiddity Advisors

As noted in the last insight about <a href="https://www.smartkarma.com/insights/the-gpif-s-new-policy-mix" target="_blank" data-smartkarma-citation="insights:38000" rel="noopener">The GPIF's New Policy Mix</a> (and its preceding <a href="https://www.smartkarma.com/insights/gpif-policy-mix-changes-ride-to-global-risk-rescue" target="_blank" data-smartkarma-citation="insights:37770" rel="noopener">GPIF Policy Mix Changes Ride to Global Risk Rescue</a>), the GPIF has changed its policy mix.Apparently, going to exactly25% each, plus or minus a fair bit, on domestic bonds, foreign bonds, domestic equities, and foreign equities, provides the lowest risk profile while reaching the GPIF's real investment rate of return target of 1.7%.<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/127/617/original/Screenshot%202020-04-12%20at%206.31.04%20PM.png?1586687503" class="editor-image img-responsive" data-smartkarma-image-id="127617"></figure><div class="content-highlight">
This is the target for the future. A target which it will meet. With 50%, or roughly 40% to up to 60+% of notional, and far more than that of mark-to-market risk, in foreign currency.
And that is the lowest risk portfolio tested. 
How do we know they will meet that target? Because they backtested the policy mix over the past 25yrs post-bubble returns to March 2019. Using annual data. It was also tested against the last 34yrs of returns. Using annual data. And everyone knows that using 25-34 data points over the past 25-34 years is likely to provide near certainty of what will happen to yen returns in foreign currency assets. [narrator: no, it won't].
As of the start of this new policy on 1 April, the yen-hedged 10yr US Treasury rate was about -0.6% rather than the average 4.1% yield over 25yrs less a yen hedge to get to 2.6%. 
The current prospective yen-hedged return is 3.2% below the bogey rate of 2.6% in yen. To get back to a yen-hedged rate of 2.6%, the entire GPIF portfolio has to take a loss of something like 7-8% at the policy mix of 25% foreign bonds. Either that or they can hold on to the bonds they have and expect USD/JPY to rise 2% a year to get to ¥130 to the dollar by March 2030.
But that is the base assumption. USD/JPY has to go up 2% a year to make this work.
Practically speaking, of course, that might not be required. If USD/yen rose and bond yields rose in the interim, the domestic equities portfolio might outperform the expected 5.6% annual return and make up for the interim losses, and income from the equity portfolio could be used to reinvest a larger amount at higher yields. The assumed correlation between the two assets in yen terms is close to zero. 
But all that requires aggressive rebalancing when the yen-denominated asset portfolios get out of whack with the policy mix rates. 
</div>All this should tell you is that the policy mix as it was when they decided this in March was substantially different than the history which informed the decision (markets move, who'da thunk?), and the result is that to match that return going forward, the yen has to weaken substantially, and consistently, and effectively permanently. That's the base investment case.<h2>The Other News Out From the GPIF is About ESG</h2>The <a href="https://www.gpif.go.jp/topics/Adoption%20of%20New%20Policy%20Portfolio_Jp_details.pdf" target="_blank" rel="noopener">presentation</a> (only in Japanese) about the change in policy makes considerable mention of the concept of ESG and stewardship, and suggests an interesting breakdown of what stewardship means for passive investing and active investing conducted by the GPIF's sub-managers. The minutes of the last several Investment Committee and Governors' meetings also refer quite a lot to ESG. The presentation and minutes also talk quite interestingly about index construction and engagement with index providers. The result is an increased emphasis on <h2>And We Have March Data And May Glean What GPIF Did in FYQ4</h2>Late last week, the Japanese Ministry of Finance reported its survey of large asset managers and trust banks of the flows in international securities, and the TSE reported the weekly and therefore March totals for trust bank activity in equities.The picture painted may tell us something remarkable about what happened in the last quarter. Much more below.

As noted in the last insight about The GPIF's New Policy Mix (and its preceding GPIF Policy Mix Changes Ride to Global Risk Rescue), the GPIF has changed its policy mix.Apparently, going to exactly25% each, plus or minus a fair bit, on domestic bonds, foreign bonds, domestic equities, and foreign equities, provides the lowest risk profile while reaching the GPIF's real investment rate of return target of 1.7%.
This is the target for the future. A target which it will meet. With 50%, or roughly 40% to up to 60+% of notional, and far more than that of mark-to-market risk, in foreign currency.
And that is the lowest risk portfolio tested. 
How do we know they will meet that target? Because they backtested the policy mix over the past 25yrs post-bubble returns to March 2019. Using annual data. It was also tested against the last 34yrs of returns. Using annual data. And everyone knows that using 25-34 data points over the past 25-34 years is likely to provide near certainty of what will happen to yen returns in foreign currency assets. [narrator: no, it won't].
As of the start of this new policy on 1 April, the yen-hedged 10yr US Treasury rate was about -0.6% rather than the average 4.1% yield over 25yrs less a yen hedge to get to 2.6%. 
The current prospective yen-hedged return is 3.2% below the bogey rate of 2.6% in yen. To get back to a yen-hedged rate of 2.6%, the entire GPIF portfolio has to take a loss of something like 7-8% at the policy mix of 25% foreign bonds. Either that or they can hold on to the bonds they have and expect USD/JPY to rise 2% a year to get to ¥130 to the dollar by March 2030.
But that is the base assumption. USD/JPY has to go up 2% a year to make this work.
Practically speaking, of course, that might not be required. If USD/yen rose and bond yields rose in the interim, the domestic equities portfolio might outperform the expected 5.6% annual return and make up for the interim losses, and income from the equity portfolio could be used to reinvest a larger amount at higher yields. The assumed correlation between the two assets in yen terms is close to zero. 
But all that requires aggressive rebalancing when the yen-denominated asset portfolios get out of whack with the policy mix rates. 
All this should tell you is that the policy mix as it was when they decided this in March was substantially different than the history which informed the decision (markets move, who'da thunk?), and the result is that to match that return going forward, the yen has to weaken substantially, and consistently, and effectively permanently. That's the base investment case.The Other News Out From the GPIF is About ESGThe presentation (only in Japanese) about the change in policy makes considerable mention of the concept of ESG and stewardship, and suggests an interesting breakdown of what stewardship means for passive investing and active investing conducted by the GPIF's sub-managers. The minutes of the last several Investment Committee and Governors' meetings also refer quite a lot to ESG. The presentation and minutes also talk quite interestingly about index construction and engagement with index providers. The result is an increased emphasis on And We Have March Data And May Glean What GPIF Did in FYQ4Late last week, the Japanese Ministry of Finance reported its survey of large asset managers and trust banks of the flows in international securities, and the TSE reported the weekly and therefore March totals for trust bank activity in equities.The picture painted may tell us something remarkable about what happened in the last quarter. Much more below.

NTT (Nippon Telegraph & Telephone) (9432 JP)

TSE Tokyo Price Index TOPIX

Recent GPIF Moves - Rebalancing & ESG