Japan’s Demographic Time Bomb Set to Go Off; World’s Largest Pension Fund May Have to Sell Japanese Bonds
Friday, February 25th, 2011
by Michael ‘Mish’ Shedlock, Global Economic Trends Analysis
It’s now official. Japan’s demographic time bomb has gone off. However, don’t look for a big crater, at least just yet, because this has started off with a whimper and not a bang.
Inquiring minds note the World’s Biggest Pension Fund May Sell Japan Bonds.
Japan’s public pension fund, the world’s largest, said it may become a net seller of bonds to cover payments in the world’s most rapidly aging society.
The Government Pension Investment Fund, which oversees 117.6 trillion yen ($1.4 trillion), in September forecast that it would sell 4 trillion yen in assets in the business year ending March 31 to fund payouts. Sales may be less than that in the year starting April as bonds reach maturity, said Takahiro Mitani, president of the fund, known as GPIF.
“We will likely be a net seller in the market,” Mitani, a former executive director at the Bank of Japan, said in an interview in Tokyo yesterday. “We certainly have to come up with an adequate amount” to pay pensions, he said, declining to elaborate on the amount.
Sales by the fund, which helps oversee public pension funds for Japan’s 37 million retirees, come as the first of Japan’s baby boomers is set to turn 65 in 2012, making them eligible for pension payments.
The GPIF, historically one of the biggest buyers of Japanese debt, held 82.4 trillion yen in domestic bonds, or 70 percent of its assets, as of September, according to the fund’s latest quarterly financial statement. That compares with 12.6 trillion yen in Japanese stocks, or 10.7 percent, 9.6 trillion yen, or 8.2 percent, in foreign bonds and 11.5 trillion yen, or 9.7 percent, in overseas stocks, the report shows.
GPIF doesn’t plan to start investing in so-called alternative assets such as commodities, real estate, infrastructure, private equity or hedge funds because the risks don’t suit its strategy, Mitani said.
“It’s too early to get into alternative investments now,” Mitani said. “Japanese investors are conservative and it’s hard to justify to the public investing in asset classes such as commodities, real estate and hedge funds.”
Japan’s 10-year bond yield is the lowest in the world, data compiled by Bloomberg show. Japan’s gross domestic product shrank an annualized 1.1 percent in the three months ended Dec. 31, the Cabinet Office said on Feb. 14, and China’s economy overtook Japan’s as the world’s second largest for 2010.
People aged 65 or older will account for 29 percent of the country’s population in 2020 and almost 40 percent in 2050, according to the statistics bureau. They accounted for 23 percent population at the end of 2010, the highest among the Group of Seven countries, data compiled by Bloomberg show. That compares with 12 percent in 1990.
Japanese pension funds posted the lowest annualized growth among 12 countries between 2004 and 2009, at 2 percent in U.S. dollar terms and unchanged in yen terms, according to the survey. Brazil reported the highest growth, 24 percent in dollars, the report showed.
Thoughts and Implications
There is not going to be a huge exodus of Japanese bonds anytime soon. However, the world’s largest fund has gone from being a buyer of bonds to a seller of bonds. The amount is not trivial.
82.4 trillion yen in domestic bonds is about 1 trillion in US dollars. That is a lot of pent-up supply, especially when the government is running an annual deficit of of about $240 billion with no external buyers at all.
Those factors put huge pressures long-term upward pressures on interest rates.
The irony in this madness is that all the Japanese people want is their money back. They are not looking for appreciation. They do not have absurd pension plan assumptions like the 8% expected returns we see in the US. They do not want stocks, or real estate. They just want cash, and they want it to be worth something.
Yet, the Japanese government was hell-bent for two decades attempting to generate inflation which would have weakened the value of those bonds.
Recently, those bond holdings have been rising with a strengthening yen. However, lingering debt from preposterous deflation fighting efforts of building bridges to nowhere must be paid back.
Horns of a Dilemma
Japan choices are to default on its debt, print money to fund interest on the debt, raise taxes effectively robbing savers of their money, or undertake huge spending cuts.
The dilemma stems from years of Keynesian and Monetarist stupidity.
Japan Plans Tax Hikes
The Wall Street Journal reports Japan Issues Budget Deficit Plan
Japan’s government pledged to balance the nation’s main budget over the coming decade under its first fiscal-overhaul plan, approved Tuesday, laying the groundwork for the daunting task of tackling the country’s massive debt.
Highlighting the challenge of such an undertaking, the government estimated that if growth remains modest, it may have to fill an annual budgetary gap of about 22 trillion Japanese yen (US$242 billion) by the fiscal year ending March 2021. If Tokyo were to raise that amount only by increasing the 5% consumption tax—one gauge being used—it would need to increase the tax nearly threefold.
Prime Minister Naoto Kan’s government will kick off the fiscal-reform campaign by capping annual spending for the next three fiscal years and keeping new government bond issuance below 44.3 trillion yen next fiscal year. The debt amount is estimated the same as in the current fiscal year that started in April. Tokyo also promised to make “utmost efforts” to lower the amount in the following years.
The budgetary blueprints represent the first fiscal-reform plans adopted by the Democratic Party of Japan since it swept to power about nine months ago. They offer the clearest picture yet of how Mr. Kan’s economic team intends to lower the nation’s public-debt level, which at nearly twice Japan’s yearly economic output is the worst among advanced economies.
Japanese government bonds rose as investors welcomed the plan. Lead September JGB futures finished the day up 0.34 at 140.82, while the 10-year JGB yield fell to 1.185%, its lowest level since January 2009.
But questions linger about feasibility of the framework. Absent from the blueprint are detailed spending-cut plans, such as how much to scale back individual budget categories like defense and education. There also aren’t timetables for specific tax increases despite Mr. Kan’s calls for doubling Japan’s consumption tax in the coming years.
“The government has yet to provide details of how it can achieve the goal,” said Masashi Shimominami, a bond-market analyst at Mizuho Securities. Some investors also remain skeptical over whether Mr. Kan will rally enough political support for heavier taxes on consumption, Mr. Shimominami said.
The release of the plan comes as Japanese officials shift their policy focus to fixing budgetary woes after receiving a wake-up call from Europe’s deepening debt crisis. “We must make sure we avoid a situation where we lose trust in the government bond markets just like Greece and, as a result, interest rates rise sharply, putting our finances in a state of default,” the guidelines said.
No Political Will For Budget Cuts
As in the US, there is no political will for budget cuts. The best the government could come up with was a plan to freeze spending for 3-years. Whoop-to-do. Bear in mind that an aging demographic will require more health care.
Will growth be sufficient to make a long-term dent in Japan’s debt? I scoff at the notion. Moreover, rising energy prices will take a big bite of of Japan’s trade surplus.
By the way, in case you missed it, Japan’s trade surplus went negative last month. Supposedly it’s a one-time thing.
Japan posts first trade deficit in almost two years
Please consider Japan posts first trade deficit in almost two years
Weaker exports to key markets gave Japan its first trade deficit in 22 months, Ministry of Finance data has shown.
The trade deficit was 471.42bn yen ($5.7bn; £3.52bn) in January, with exports up 1.4%. Analysts had expected export growth to be closer to 7%.
Japan has struggled to boost exports as a stronger yen dents demand.
It recently lost its position as the world’s second-largest economy to China.
However, analysts said they expect exports to rebound.
That should help drive economic growth in Japan, albeit at a pace that is slower than many experts may have predicted.
One of the main reasons for the slower growth was weaker demand from China, where the government is battling inflation and signs that its economy may be overheating.
Japan is counting on increased sales to China when China is clearly overheating and will have to cut back. How do you think that fantasy is going to work out?
So, it’s back to tax hikes. To do it all with tax hikes, Japan would need to hike the VAT by 200%, from 5% to 15%. Is that going to fly with the voters?
Nonetheless, let’s assume Japan does hike taxes. Those tax hikes would strengthen the yen, which in turn would hurt Japan’s export growth and corporate profits.
My suspicion is Japan will print money, cheapening the yen, as the most convenient way out. Printing money will make matters worse in the long haul of course, but it will put off making any tough choices now.
Mike “Mish” Shedlock
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Tuesday, February 15th, 2011
Domenic Bellissimo discusses his views on corporate bonds in 2011.
Dierdre McMurty interviews Domenic Bellissimo, of Dynamic Funds on the subject of investing in corporate bonds. Bellissimo shares his view on current areas of opportunity, as well as areas that they are avoiding, and provides insight dispelling the BBB Public Private bond issuances.
Domenic Bellissimo was previously worked at a big bank on the Risk Management side, and he also worked at a big government pension fund on the credit analysis side.
DM: What did you learn in those previous positions that you can apply now?
Domenic Bellissimo: I spent a lot of time analyzing companies in the credit market learning how to structure transactions. What works, and what doesn’t. Basically, best practices. So a lot of that has been formulated and made its way into our current credit investment process.
DM: What’s your process? How do you go about setting up to invest in a corporate bond?
Domenic Bellissimo: We focus on three main things:
First we’ll screen the environment:
1) where do you want to be?;
2) where’s the best place to be investing?
3) where do you not want to be investing?
Then we’ll analyze each company, management teams, we’ll analyze the securities;
Lastly, we’ll monitor each investment on an ongoing basis to make sure its still a safe and sound investment.
DM: in a webcast back in December, you expressed some concerns about the current environment for corporate bonds; can you build out on that a little bit?
Domenic Bellissimo: Yes, actually, what we’re seeing over the past year is an increase in what we consider to be red flags. So one thing is risk premiums, which are compressing especially for the weaker issues (securities). Companies that historically were not able to issue in the public markets are now doing so, and these deals are oversubscribed. Covenants are starting to weaken, and lastly there is an increase in shareholder friendly activity, such as share buybacks.
DM: Just to follow up on your last point. You referred to “shareholder-friendly” activities, as something negative though … Why is that?
Domenic Bellissimo: Shareholder-friendly activities have the potential to undermine the value of credit-worthiness of any bond, so you have to be able to assess every management action in order to determine whether or not it has a negative impact on your investment.
DM: And Which industry sectors do you currently find the most attractive?
Domenic Bellissimo: We’re currently focusing on those sectors which have good cash flow generating abilities, so TELCOs and Cable for example. Sectors like the energy sector, which have a strong long term view on the underlying commodity, that being oil. And, also, best in class real estate companies.
DM: And what about the sectors where you’re really uncomfortable and you’re staying away?
Domenic Bellissimo: Well, first of all we’re underweight in financials across all of our mandates, and that’s predicated on the European situation and the concerns there, and [as well] a significant underweight in long dated financials [issues].
DM: And looking at the North American market, where are you finding the best valuations right now, in the corporate field?
Domenic Bellissimo: It ebbs and flows between Canada and the U.S., but right now I’d say that the U.S. is showing very good valuations especially on the recent back up in yields.
DM: What are the other areas, Domenic, you identified in that December webcast as a point of concern, were the bonds that were issued around public/private sector partnerships. Can you tell us a little bit more about your anxiety there?
Domenic Bellissimo: The public/private sector issuances, or triple B (BBB), as they’re commonly referred to, is something that historically has been the domain of insurance companies and pension funds. They’re issued in order to help finance infrastructure projects, such as hospitals. We look at them and we are concerned, and we’ve stayed away from them for three main reasons: 1) there’s a significant amount of construction risk, that frankly is hard to quantify, 2) many people look at these and view them as quasi-government issuances and frankly they’re not, and 3) they’re very illiquid securities.
DM: Thank you for that.
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Wednesday, December 22nd, 2010
by Leo Kolivakis, Pension Pulse
The BBC reports, Public pension schemes ‘should be career average’:
Lord Hutton’s review of public sector pension schemes has been urged to recommend they be changed to career average schemes.
The National Association of Pension Funds (NAPF) says such a switch would be the best way to keep the schemes going in the face of rising costs.
It would also protect the interests of lower-paid workers, the NAPF said.
Most public servants are in better final-salary schemes, whose costs are rising due to increasing longevity.
Lord Hutton indicated he would recommend this policy when, in October, he published his initial findings on the future of the pension schemes.
His independent commission, set up by the coalition government, covers staff in the civil service, NHS, local government, education, police, armed forces and fire service.
Lord Hutton’s first recommendation was that members of most of these schemes should pay higher contributions.
The government has said it will adopt this policy, with contribution rates likely to go up by an average of 3% of salary.
“Career average pensions are the most promising option for providing a sustainable, affordable and fairer public sector pensions system,” said Joanne Segars, chief executive of the NAPF.
“While it will reduce the costs of public sector pensions, it will also protect lower-paid workers who don’t usually have significant salary spikes late in their careers,” she added.
The idea was supported by the London Pension Funds Authority (LPFA), which runs the local government pension scheme for councils in London.
“The conclusion we have drawn is that there is a need to share risk more effectively between members and employers,” said the association’s chief executive Mike Taylor.
“We believe the CARE [career average] system is the most appropriate solution to achieve this.”
A final-salary scheme pays a pension based on both the number of years for which a worker makes contributions, and their final salary at retirement.
A career average scheme is fundamentally different.
A worker’s pension builds up as a proportion of each year’s salary during their employment.
In most cases, this means the pension paid out will be significantly lower than in a final-salary scheme.
As such, career average schemes are much cheaper for employers to finance, which is why Lord Hutton, and now the NAPF, have come out in favour of them.
At the moment, the only significant career average scheme in the public sector is the one that has been open since 2007 for new recruits in the civil service.
The universities’ scheme – not part of the Hutton review – is currently considering making a similar change for new staff.
Lord Hutton will publish his final report in time for the 2011 Budget and has received 137 submissions.
In October, he acknowledged that the future cost of paying for the public sector schemes – all of which are paid out of taxation, apart from the local government scheme – had already been cut by as much as 25%.
Among the typical changes already in place have been the introduction of a higher pension ages for new recruits.
The government is also about to enforce a lower level of inflation-proofing for all public schemes by moving from the use of the retail prices index (RPI) to the slower rising consumer prices index (CPI).
I’m not going to debate the pros & cons of final salary versus career average pension schemes, but it’s obvious that policymakers in Britain are looking to make cuts to pensions and this, along with the switch to CPI, are all part of the measures they’re introducing now.
The US is also taking note as many states are struggling to cope with their own ballooning pension costs. CBS’s 60 Minutes had a segment on the municipal bond market this past Sunday which took a close look at the financial mess plaguing many states (see videos below or click here).
Will a collapse in the municipal bond market be the next major hurdle? Who knows? But I can guarantee you the Fed and the US government will do whatever it takes to avoid any collapse of the municipal bond market. In the meantime, pension reforms will continue around the world, and many policymakers will be looking at Britain to see how their reforms are working out and whether they can bolster their pension system now that the day of reckoning has arrived.
Copyright (c) Pension Pulse
Tags: Appropriate Solution, Career Average, Career Salary, Civil Service, Coalition Government, Councils In London, Fire Service, Government Pension, Independent Commission, Initial Findings, Local Government Education, Local Government Pension Scheme, Lord Hutton, Lpfa, Mike Taylor, National Association Of Pension Funds, Pension Schemes, Public Pension, Public Servants, Segars
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Wednesday, October 20th, 2010
Derek Abma of Postmedia News reports in the Montreal Gazette, Canada’s pension ranked among best, but could be better:
Canada’s pension system is one of the best in the world, though there is room for improvement and the recent global financial crisis has affected its sustainability, a report said Wednesday.
The second annual Melbourne Mercer global pension index ranked Canada fifth out of 14 countries for its pension system’s adequacy, sustainability and integrity.
Canada was fourth last year, but more countries were included in this year’s rankings, including Switzerland, which finished second behind the Netherlands.
Canada’s overall score was lower at 69.9 compared to 73.2 last year.
“Not surprisingly, the (global financial crisis) has threatened the sustainability of public and private pension systems in several countries through the decline in asset values and an increase in government debt,” said David Knox, a senior partner with consultancy group Mercer, which did the study on behalf of the Australian Centre for Financial Studies.
“This was reflected most acutely in the scores for Canada, the United Kingdom and the United States.”
Scott Clausen, another partner with Mercer, said Canada could take moves to improve its pension system, such as increasing coverage in employment-based pension plans, particularly for “middle-income employees in the private sector.”
It was also recommended that Canada consider raising the government-pension age of 65 as life expectancy continues to increase.
“Increased life expectancy is a theme that is common to all of the countries in the index,” Knox said. “As the gap between pension age and life expectancy widens, pressure on public pension systems will increase. This highlights the need for governments to continue to review their state pension or retirement age, and focus on increasing the adequacy of the private system.”
Rounding out the top five rankings is this study was Sweden at third and Australia at fourth. The United States was 10th, down from sixth last year.
Janet Novack wrote a comment on why the US pension system ranks low:
A new report comparing pension systems in 14 countries, ranks the U.S. a lowly 10th, behind the Netherlands, Switzerland, Sweden, Australia, Canada, the United Kingdom, Chile, Brazil and Singapore. It leads France, Germany, Japan and China.
The index, compiled by Mercer and the Australian Centre for Financial Studies, attempts to compare the widely varying systems of the countries in three broad areas: adequacy, sustainability and integrity. Not surprisingly, the U.S. ranks low on adequacy—lower than Australia, Canada or any of the European nations. But it scores slightly above average on sustainability, meaning the ability to deliver what’s been promised. The U.S. had a score of 54 on adequacy and 59 on sustainability, compared with an average of 63 on adequacy and 52 on sustainability for all 14 countries and 76 on adequacy and 72 on sustainability for the top-ranked Netherlands.
By contrast, France scored 75 on adequacy, but only 30 on sustainability. That nation, of course, is now wracked by protests over President Nicolas Sarcozy’s push to make its pension system more sustainable by raising the minimum age for a partial pension from 60 to 62 and for a full pension from 65 to 67. In the U.S., the minimum age to receive Social Security retirement benefits is already 62, while the “full retirement age” for Social Security is now 66 and is slated to rise slowly to 67 for those born in 1960 or later. President Obama’s deficit reduction commission might recommend it go higher.
The U.S. integrity score of 60 was also well below the average of 73. That category includes such factors as regulation and costs.
Overall, the pension experts judged the U.S. system, as well as those in the UK and Canada, as less sustainable than just a year ago, when they conducted their first joint international study. David Knox, the senior partner in Mercer’s Retirement, Risk and Finance business who oversaw the study, said those three nations were the “most severely affected” by “declines in asset values since 2008 and increases in government debt.’’ Consultant Mercer is a subsidiary of Marsh & McLennan Companies.
Pensions are fast becoming the hot political issue of the next decade. Demographics, exploding debt and longer lifespans are all weighing on global pension systems. This is a long-term structural theme that will require tough political choices and compromises from all stakeholders. Below, an update on protests in France.
Copyright (c) Leo Kolivakis
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