Japan’s pension funds target investments in riskier assets, ILS included

Private Japanese pension funds are increasingly shifting their investment strategy towards riskier assets and this includes a growing interest in insurance-linked securities (ILS), catastrophe bonds and reinsurance linked investments.

Private pension funds in Japan control a massive JPY90 trillion, around $888 billion and are now turning away from Japanese government bonds and similar assets given the extremely low returns. Instead, according to this Wall Street Journal piece, the Japanese pension funds are turning their heads to riskier assets such as real estate and catastrophe bonds.

Even Japan’s $1.25 trillion public pension fund has moved away from government bonds in recent times, with the shift in invested assets playing a role in stimulating Japan’s property and infrastructure sector.

With such a huge amount of assets now actively exploring alternative asset classes and riskier returns, the ILS and catastrophe bond space stands to benefit. The timing is a key factor here, Japanese pension funds have been exploring the ILS asset class for a number of years and some are now comfortable enough to begin allocating more meaningfully to the space.

Japanese pension funds can take a significant amount of time to explore and become familiar with a new asset class, plus the low return targets of Japanese pension funds, often below 5%, has made the ILS space difficult for them to enter. Now that ILS has matured and more strategies are available, including some lower risk/return ones, the asset class is likely more attractive to the Japanese pension funds which have put the effort into understanding reinsurance and catastrophe risk as an investment.

Japan’s pension funds have historically invested in domestic assets but the Japanese government’s aggressive bond-buying and other economic factors have increased the concerns that the market may be at risk. Combined with an interest and need for higher returns this has led Japanese pension fund investors to look elsewhere.

The WSJ article cites the JPY150 billion Ricoh pension fund which now has as much as 5% of its assets invested in non-life insurance-linked assets. This includes an allocation to insurance linked securities such as catastrophe bonds.

As Abenomics continues to change the economic and investing landscape in Japan we can expect pension funds to increase their willingness to look outside of their usual assets for stable returns. Japanese pension funds are not looking for more risk, but are looking for another source of stable return, something that a low-risk and diversified ILS and catastrophe bond portfolio could provide them with.

As a result we should expect an increasing amount of Japanese pension fund capital to come into the ILS and catastrophe bond space. The lower yields seen in the market this year may not worry them, as long as the risk is not too high, given the lower return targets of the corporate Japanese pension market.

ILS managers should take note, Japan may prove to be a very interesting market to enter. Some ILS managers already make regular marketing trips to visit large Japanese pension funds. This is likely to increase and we may see a growing number of ILS managers launching Japanese Yen denominated ILS funds as well.

As we’ve written before, the world’s pension funds are still only dipping their toes into investing in ILS and reinsurance linked assets which means there is a long-way to go and much more capital to come into the sector as pension funds first discover, then learn about, gain an understanding and appreciate the benefits of the ILS asset class.