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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Imagine a policy that adds 1 per cent of GDP a year to the fiscal resources of a large, advanced economy. This policy works like magic. The money appears out of nowhere, with no rise in taxes, no cuts in spending, no assets sold and no debt to pay back. Such a policy would have great appeal to cash-strapped governments around the world and is surely too good to exist. Nevertheless, exist it does. Any guesses? The answer is a 2014 reform to the Government Pension Investment Fund of Japan, the world’s largest pool of retirement savings, in which it took on some currency and equity risk.
Undertaken by former prime minister Shinzo Abe, the 2014 reform shifted the GPIF from a largely domestic portfolio, with 60 per cent held in Japanese government bonds, to one that is 50 per cent equity and 50 per cent international. According to Stephen Jen and Joana Freire of Eurizon SLJ Capital, the portfolio has grown from ¥137tn in 2014 to ¥226tn today, compared with the ¥168tn at which it would now stand if the fund had kept it unchanged. The extra return amounts to about 10 per cent of Japan’s GDP, or $370bn, which must make it the most lucrative asset allocation review in history.
The portfolio has benefited, of course, from the weakness of the yen, which fell from roughly ¥100 to the dollar to roughly ¥150 over this timeframe, but that is the point of taking currency risk, not a lucky accident. A period of bad asset returns could wipe out some of the gains. This is, however, a policy experiment that the world should study. Here are six lessons.
First, Japan has reason to be grateful to Abe, who was prime minister from 2012 to 2020 before his assassination in 2022. Opponents attacked the GPIF reform as speculation with the public’s retirement savings but Abe and his advisers showed leadership, riding out periods of bad publicity when the fund’s value went down. The GPIF reform may not be his greatest legacy but it is one to be proud of.
Second, it highlights the importance of looking at net rather than gross public debt. Japan famously has the world’s largest gross public debt at 252 per cent of GDP. Its net public debt stands at 158 per cent of GDP, with the assets in the GPIF making up a chunk of the difference. Imagine an alternative reform in 2014, which used the GPIF money to cancel government bonds. In that case gross debt would have fallen, but Japan would have missed out on the excess returns from the investment portfolio and net debt would now be 10 percentage points higher.
Third, the GPIF’s shift shows a different way to think about public finances. In some sense, a government is like the ultimate university endowment fund or life insurance company: it is designed to exist forever, it has long-term obligations to future pensioners and a huge capacity to absorb risk.
The government can invest in public sector assets that will generate future tax returns, such as education and roads, but it can invest in private sector assets as well. In circumstances where the private sector is hungry for safe assets such as government bonds, and willing to buy them at very low interest rates, it may well make sense to issue more, increase the public sector’s leverage and invest for a higher return. Jen and Freire suggest that the US Social Security Trust Fund, which is currently an accounting entity that only invests in special US Treasury bonds, should follow the GPIF into other assets.
Fourth, the GPIF reform was relatively conservative. The portfolio shift was made consciously, with careful attention to risk, asset management by professionals and politicians kept at arm’s length. That makes a depressing contrast with an economically similar scheme in the UK, whereby local governments sought to fix their lack of tax revenue by borrowing billions of pounds from the central government, and investing it in commercial property and other assets. A number, such as Thurrock, Woking and Warrington, have got themselves into deep financial trouble. It will always be easy to confuse prudent use of the state’s balance sheet to fund long-term liabilities using long-term assets, and speculation to keep short-term tax rates low.
Fifth, the GPIF’s shift could apply to other pools of assets. For example, Japan is one of a number of Asian countries that maintains foreign exchange reserves much greater than it needs. If Tokyo does not want to take advantage of the weak yen to sell some dollars and retire some debt — which would be quite sensible — then it could shift some of these reserves into equities too, or hand them over outright to the GPIF. The way Hong Kong handles the investment portion of its Exchange Fund is an interesting example.
Finally, there is a case to make this kind of reform early. Not only are the benefits accrued and the risks best managed over time, but the world continues to age and the demand for pension-paying assets rises with it. The return of inflation has made everybody feel better about returns but there is little sign that real interest rates — after inflation — have moved sustainably higher.
In finance there is never any free lunch. Return always comes with risk. But as ageing societies confront a rising fiscal burden, the success of Abe’s GPIF reform shows the merit, for governments, of thinking less like debtors struggling to pay the bills, and more like investors with large obligations, large balance sheets and a very long time horizon.
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