An Unconventional Pension Fund Bets on Volatility’s Return

(Bloomberg) -- A small Japanese pension fund known for its aggressive bets on alternative investments is changing tack.

The West Japan Machinery Pension Fund has an unconventional strategy with 90% of assets invested in the likes of loans and private equity. While still committed to alternatives and disavowing sovereign bonds, it has been pivoting away from low-liquidity assets such as PE and infrastructure debt, said chief investment officer Yoshisuke Kiguchi.

“Instead, we have recently increased convertible bond arbitrage quite a lot because volatility is rising,” 55-year old Kiguchi said via phone from Matsuyama, western Japan. “We’re also boosting the weighting of multi-strategy funds that include long/short in stocks and some distressed assets.”

While small -- the fund oversees 20 billion yen ($189 million) -- West Japan Machinery has led Japanese private pensions in going out of the way to generate returns in a low-yield environment. The changes Kiguchi, formerly from Sumitomo Life Insurance Co., are executing reflect one extreme of how pensions are navigating the investing landscape as the pandemic forces a rethink.

Investors are taking a long volatility bet when they buy convertible debt. This is because as stocks see more price swings, the chance that the convertible bond pays off also increases.

Corporate Pensions

West Japan Machinery’s alternative-heavy approach has delivered average annual return of 6.43% since 2009, though its overall performance slipped to minus 0.28% for the fiscal year ended March. Both sets of results are better than Japan’s Government Pension Investment Fund, a benchmark used by others in the nation.

The GPIF, with a traditional focus on stocks and bonds, posted returns of minus 5.2% for the last fiscal year, and 4.2% on average annually since 2009. Corporate pension funds in Japan have increasingly been taking more risks, allocating a record 21.3% of their portfolio into alternatives, more than in domestic bonds, according to a JPMorgan Asset Management survey last year.

“There may be some alternative assets that are seeing impact from the coronavirus,” said Kentaro Otani, executive director at JPMorgan Asset. “Core real estate, which doesn’t involve development, has undergone adjustments from a high valuation, so many are now seeking opportunities for investment there.”

‘Too Popular’

Low-liquidity assets, including bank loans, accounted for 40% of West Japan Machinery’s assets five years ago, but they’re now less than 20% as they got “too popular,” Kiguchi said.

While stocks and high-yielding corporate debt form just about 10% of its portfolio, West Japan Machinery has become much more active in managing equity flows this year, he said.

The pension, which outsources active management, dumped all its stock holdings in early February with the pandemic unfolding, and then bought in March as central banks flooded markets with liquidity. It sold again in September, and is now looking to buy, Kiguchi said.

“One impact from the coronavirus is that it became clear government will have to take policies to provide ample funds, which underpin financial markets and is very positive for stocks,” Kiguchi said. A key risk would be an improvement in the crisis, leading policymakers to withdraw support and drain liquidity, he added.

The “happiest scenario for stock markets is for the situation to remain unclear,” he said. Kiguchi also puts money in U.S. high-yielding bonds averaging shorter than two years to maturity with single or double-B ratings.

West Japan Machinery was formed in 2019 after the merger of two corporate pensions, one of which was Kiguchi’s Okayama Metal & Machinery Pension Fund. It oversees the workers’ savings of some 300 companies including Kyoto Industrial Association Inc., ship component manufacturer Nakashima Propeller Co. and agricultural machinery maker Minoru Industrial Co.

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