The Chikyoren, one of Japan's Big Four public pension funds, selected its first manager of international real estate last week. The announcement promises to be the first of a stream of similar decisions that could see billions of dollars in assets flow into overseas property.
The $185 billion Chikyoren has chosen UBS Asset Management, a subsidiary of UBS (UBS) , as its international manager for real estate. Simultaneously, it identified J.P. Morgan Asset Management, a subsidiary of J.P. Morgan Chase (JPM) , as its first manager of international infrastructure.
Those moves should ultimately be very good news for managers of private property and infrastructure funds -- such as Blackstone (BX) , the world's largest private-equity manager. BlackRock (BLK) , the world's largest asset manager, also stands to gain.
The public pension funds are not permitted to invest directly into real estate, according to Yukihiko Ito, the managing director at Asterisk Realty & Placement Agency. He says the funds are now negotiating with the Ministry of Health Labour and Welfare, which supervises them, to change the rules so they can invest in limited partnerships.
"Their investment will have to be through funds, although there are no clear guidelines for that yet," Ito explained in an interview with Real Money. He has been watching the minutes of their discussions for guidance as to their direction.
Their allocation would not include real-estate investment trusts. REITs count towards the equity allocation, so they wouldn't fall under alternative investments. Funds such as the Japan Teachers' Mutual Aid Co-operative Society have already announced that they are taking stakes in REITs.
There's obviously a vast difference in the liquidity of a market-traded REIT over a private fund that invests in buildings. Ito expects the first wave of capital to go into core funds, although once the pension funds become familiar with that, he anticipates they will experiment with riskier asset classes, such as value-add and opportunistic funds.
Japanese institutional investors have been very reticent to invest in real estate after getting their fingers singed in the 1990s, when Japan's property bubble burst. But negative interest rates and the poor performance of their favorite holding, Japanese government bonds, are forcing them into other assets. They are essentially losing money by holding Japanese bonds and cash. Given long-term liabilities in terms of pension-fund payouts, the funds realize they must increase the profitability of their investments.
The Chikyoren's groundbreaking move should inspire other institutional investors to follow suit.
"Japanese regional banks and corporate pensions will follow this, and perhaps insurance companies, as well," Ito said. Japan Post could also follow suit. Poor domestic returns "have really has been pressuring [these types of firms] for a very long time."
They have considerably greater assets than the public pensions. The Big Four public pension funds had $1.4 trillion in assets as of the end of last year. They will likely invest around 5% in alternatives, with an initial 0.5% to 1% of assets going into international property, and a similar amount into Japanese real estate. That suggests an initial allocation of $28 billion to property in total.
Japan Post alone has $2.6 trillion in assets. Regional banks have more than $3 trillion in assets, a similar amount to Japanese life-insurance companies. Then you have liability insurance companies and the major Japanese banks on top of that. A 2% combined allocation to domestic and international real estate would therefore be worth around $172 billion -- for starters.
The real heavyweight in terms of pension funds is the Government Pension Investment Fund, or GPIF. It had ¥140 trillion ($1.3 trillion) in assets at last count, making it the largest pension fund in the world, according to Towers Watson and Pensions & Investments. It has announced plans to invest in real estate, but has not yet put out requests for proposals from fund managers.
Japanese funds' markets of choice would typically have been the United States and the United Kingdom. But the Brexit vote will discourage them from taking U.K. positions now, Ito believes. They will then have to assess whether the market is too crowded, if they shift their focus entirely to U.S. property. Holdings in the European Union and Australia would likely be next on the shopping list.
Blackstone appears to have no trouble raising billion-dollar funds. The best managers already have investors lining up for allocations, so Japanese institutions will have to make smart decisions in manager selection.
"Some of the fund managers have a very long capital queue," Ito said. "So many investors are waiting in line, and good fund managers have too much capital and can't spend it all."
The Chikyoren, officially called the Pension Fund Association for Local Government Officials, had requested proposals for managers of both domestic and international alternative asset classes last July.
Both UBS and J.P. Morgan have set up Japanese investment platforms -- a key factor in the pension fund's selection.
"People have to be aware there's a big cultural difference between Japanese investors and overseas asset managers," Ito said. UBS and J.P. Morgan "are established, and they have a platform on the ground. If public pensions are investing into overseas products, I guess they will not be willing to select overseas investors who don't speak Japanese, or who only report in English."