World’s Top Pension Fund Faces Moment of Truth on China Debt

(Bloomberg) --

The world’s largest pension pot will soon have to choose between political sensitivities and cold hard returns.

With FTSE Russell set to proceed with a plan to add Chinese debt to its benchmark global bond index from October, Japan’s Government Pension Investment Fund will now have to decide whether to put its money into China’s sovereign debt, or risk lower returns elsewhere.

Investing Japanese pension money in Chinese government debt is likely to be a politically unpopular decision for the $1.63 trillion GPIF, considering the historically tense relations between the two countries. Those relations may get even frostier if Japan bows to pressure to join other major democracies in imposing sanctions on China.

Yet it might not be easy for the fund to ignore high-yielding Chinese debt while also meeting its benchmark returns, with yuan-denominated debt already excluded from the actively-managed portion of foreign bond holdings. China’s 10-year notes yielded around 3.2% Wednesday, well above the 0.5% equivalent on the FTSE gauge.

“It’ll be important for the fund to evaluate China’s risks properly by strictly focusing on its governance and its ability to service its debt,” said Takatoshi Ito, an economist at Columbia University who formerly headed a Japanese government panel to reform the GPIF.

Japanese Resistance

The GPIF’s decision will also be crucial for other Japanese public and private pension funds which have been mulling opportunities to invest in Chinese government debt.

Reuters reported in January that FTSE Russell was facing resistance from some Japanese investors, including the GPIF, to its plans. Masataka Miyazono, the fund’s president, said at the time that it would wait until the consultation period had concluded before reaching a decision. “We want to discuss it thoroughly internally and decide our strategy,” Miyazono said. A GPIF spokeswoman said Tuesday the fund was still considering its response.

The index provider’s decision to include China in the FTSE World Government Bond Index was made in September. In a statement Tuesday, it estimated Chinese sovereign bonds would hold about a 5.25% weighting in the global gauge after a phased inclusion over a period of 36 months. That would make it the sixth-largest weighting on the index, with the addition set to take longer than the 12 months initially envisioned, following market feedback.

“The weighting of China in the index will be among the biggest of major countries and looking at the performance, it will be extremely hard for investors to beat the benchmark if China is excluded from the index,” said Tatsuya Higuchi, executive chief fund manager at Mitsubishi UFJ Kokusai Asset Management Co.

The GPIF has a target allocation of about 25% of its portfolio for foreign debt. It held a total of about 15.8 trillion yen in the passively managed portion of its overseas bond portfolio that tracked FTSE’s WGBI, which excludes Japan, according to the most recent data from March of last year. The fund also managed a small amount of money in a separate customized WGBI.

Japanese investors are no strangers to China’s bond market, having stepped up purchases almost four years ago after Beijing established a link to facilitate overseas investment through Hong Kong. Data from Japan’s Ministry of Finance showed Japan’s investors have been net buyers of Chinese debt for all but two months since September 2017, when purchases reached an all-time high. A rolling 12-month sum of net buying reached 707.4 billion yen ($6.4 billion) in January.

Strained Relations

Japan’s recent relations with China have been strained by territorial disputes and disagreements over an intertwined history. Increasing tension around the disputed islands known as Senkaku in Japan and Diaoyu in China, as well as Beijing’s recent passing of a law allowing its coast guard to fire on foreign ships, have turned some in Japan more hostile.

The relationship is further complicated by Japan’s dependence on China as its largest trading partner, while having its security guaranteed by the U.S. Some in the country’s ruling party are calling for Japan to join the other Group of Seven nations in applying sanctions to China over human-rights violations.

Japan Faces Pressure to Join China Sanctions Ahead of U.S. Trip

On top of politics, there are also practical issues. Investors have concerns about liquidity and the complexity of settling trades, as well as worries about the amount of information they will get from China, said Eiichiro Miura, general manager of the fixed-income department at Nissay Asset Management Corp.

“People may not take positively the public pension fund investing heavily into a market where there are capital controls,” Miura said. “Political factors could be the reason for the GPIF to avoid Chinese bonds.”

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