Japan's Massive Government Pension Fund Shakes Real Estate World

 | Dec 19, 2017 | 10:00 AM EST
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An investment-allocation process has begun that any fund manager should watch, particularly those involved in alternative assets such as real estate. It's also a process that is of note to all investors in top-class "core" real estate in the world's prime business cities.

The Government Pension Investment Fund (GPIF) on Tuesday said it had appointed Mitsubishi UFJ Trust and Banking, part of the Mitsubishi UFJ Financial Group (MTU) , to oversee its real-estate investment strategy in Japan.

This will see it invest in core properties: blue-chip buildings with virtually no chance of dropping in value (unless everything else in the world does), and that generate low but stable rental yields. Ultimately, through this allocation, we can expect a sizeable chunk of money to be heading toward investment in the prime office buildings in Tokyo.

"The long-waited action was made finally," Yukihiko Ito with the advisory company Asterisk Realty & Placement Agency, said. "We expect their next announcement for managers for overseas real estate will have more impact for the market, and more Japanese investors to follow suit."

Blackstone Group (BX) , as the world's largest private-equity investor and manager of a huge global real-estate portfolio, is the natural destination. BlackRock (BLK) , as the world's largest asset manager, must also be in the mix. 

Mitsubishi UFJ will be establishing a fund of funds for GPIF. Although that's a strategy that offers good diversification, it's a structure that more experienced institutional investors have been avoiding since they pay double fees (to the fund of funds and the underlying funds), and also have less clarity as to the exact assets that they hold.

The GPIF is the world's largest pension fund. It topped the ranking released in September by Willis Towers Watson of the world's 300-largest pension funds, and has topped every annual tally since 2002.

At $1.2 trillion in assets, the GPIF is an incredible 34% larger than the second-place fund on the list, the Government Pension Fund of Norway, which has "only" $893 billion under management.

GPIF actually now manages $1.35 trillion as of the end of June -- the Willis Towers Watsons figures come as of the end of last year. It has been struggling. For the first half of the year, it returned 3.5%, buoyed by the rally in world equity markets. The same time in 2016, it lost 3.9% at a time markets were falling.

Japanese institutional investors used to simply dump most of their money into Japanese Government Bonds. But the central Bank of Japan has brought interest rates basically to zero, and even orchestrated a negative yield on mid-term 10-year JGBs. That is pushing Japan's huge pension funds to consider riskier (marginally) strategies.

Real estate is a good fit. A top-rate building with good tenants on long-term leases in the center of a gateway business city (New York, London, Sydney, post-Brexit Paris and Frankfurt) is virtually as good as a bond -- better, if you throw in capital appreciation. They don't come cheap. But these pension funds are seeking to make massive allocations anyway, so big-ticket deals suit them.

Yet the GPIF is well behind its peers in terms of its allocation to alternative strategies. On average, pension funds have 21.1% of their portfolio in alternatives and cash, with 41.7% in equities and the other 37.2% in bonds.

The GPIF began reducing its allocation to bonds in 2014, for the first time in its history, increasing its allocation to equities both foreign and domestic instead. It began looking for managers of alternatives as of April, marking out its intentions to move money into infrastructure and private equity as well as real estate.

It has set a cap of 5% of assets on its alternatives exposure. But as of the end of last year, its alternative allocation was essentially nothing, a mere 0.07% of assets. 

Asian pension funds in general have been slow to allocate to alternatives. They've only placed 6.6% of assets in that category, the global averages skewed by the 34.7% of assets that pension funds from North America have in alternatives.

Freeing up some of that Asian allocation for real estate, private equity and hedge funds would therefore produce a strong flow of capital into those asset categories. Managers in the Asia Pacific region shepherd a total of $4.1 trillion in assets. Even a doubling of the allocation to alternatives would push a cash wedge of $271 billion into the asset class.

Bringing the allocations in line with the global averages would mean a cash inflow of $595 billion. Half a trillion dollars. Plenty to go around for many a manager.

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