Policy Asset Mix

PFA recognizes policy asset mix as its most important investment policy and places it at the center of its pension asset investment and risk management.
PFA formulates its policy asset mix from long-term perspectives and does not change it based on uncertain short-term market forecasts. On the other hand, the relationship between pension assets and pension liabilities ("funding ratio," or the ratio of pension assets to pension liabilities) does change in line with increases and decreases of pension assets due to market fluctuation. Alternatively, it is conceivable that future pension liabilities will differ from initial scenario, or structural changes in the market environment may occur over the long term. As such, the conditions envisioned when the policy asset mix was first formulated may change over time. If that is the case, PFA will review the policy asset mix based on its best estimate at the time and amend it as necessary. We regularly review and confirm whether the current policy asset mix reflects the impact of various changes and is the most appropriate portfolio to achieve our investment objectives and targets.
The pension assets that we manage and invest can be divided into two portfolios according to the characteristics of pension liabilities. One is the portfolio for assets associated with Basic Pension, and the other is the portfolio for assets associated with Portable Corporate Pensions. We tailor the formulation of policy asset mix to the respective pension liabilities.

Policy Asset Mix for Basic Pension

Pension assets associated with Basic Pension are assets associated with basic pensions proposed to be transferred from Employees' Pension Funds to PFA and subrogated pensions collected from Employees' Pension Funds that were dissolved by March 2014, and assets associated with pension benefits, etc. based on the amounts equivalent to lump-sum withdrawal payments (early seceding) and dividends of residual assets (dissolution and termination) transferred to PFA by September 2005. Pension resources (subrogated portions) for paying part of the Employees' Pension on behalf of the state are included in basic pensions and subrogated pensions.
The liabilities of subrogated portions are to be assessed based on the investment return of the main Employees' Pensions, and the assets of the main Employees' Pensions are managed by the Government Pension Investment Fund (GPIF). GPIF invests a large portion of the assets entrusted to it in the market, and mirroring the GPIF's investment approaches will allow PFA to achieve similar results to the GPIF. This means that there will be no excess or deficit in pension finance for the subrogated portions. This allows PFA to hedge (offset risk) the liabilities of the subrogated portions.
On the other hand, in terms of the "additional" portions of basic pensions (the sum of the portable portion of corporate pension plans after exclusion of the subrogated portion from pension assets associated with Basic Pension plans), because pension liabilities increase each fiscal year based on the planned interest rate, returns above the planned interest rate (in the 4% range) need to be achieved. The ratio of the liabilities of subrogated portions to that of portable portions is approximately 3:1, although this varies in line with changes in cash flows and market fluctuations. For assets associated with Basic Pension, we formulate the policy asset mix from the following perspectives. For approximately three-fourths of the assets, we consider hedging liabilities of subrogated portions, while taking into account the investment executed by GPIF, and for the remaining one-fourth of the assets, we consider how to achieve stable returns in the range of 4% across the entire asset portfolio.
Even if the planned interest rate of the portable portion is in the range of 4%, because the portable portion accounts for only about one-fourth of pension liabilities, it will be approximately 1% when translated to total assets. As the liabilities of subrogated portions can be hedged with a portfolio similar to that of GPIF, we increase the incorporation of risk assets into our portfolio within the acceptable range of risks compared to the GPIF's portfolio, with the aim of achieving a return of more than 1%. The extent of the increase in risk assets varies depending on the funding level. If the funding ratio is in surplus, the required return of the portable portion when translated to total assets will be lowered in proportion with the extent to which the value of the assets exceeds the pension liabilities, which means that the ratio of risk assets can be reduced.
As such, given the nature of the subrogated portions of Basic Pension, which account for about three-fourths of the portfolio, being hedgeable, the required return of the additional portion when translated to total assets will change due to fluctuations in the funding ratio, and risk asset allocation can be adjusted accordingly. Therefore, from the perspective of risk management, we formulate the policy asset mix for Basic Pension, in accordance with the funding levels of each asset class to control their risk volume appropriately. In this way, we conduct dynamic management to adjust asset allocation in response to changes in funding ratios. For Basic Pension, the probability of future underfunding can be reduced by reducing risks in line with improvements in funding ratios. This approach enables the stabilization of pension finances.

Policy Asset Mix for Portable Corporate Pensions

Pension assets associated with Portable Corporate Pensions are assets associated with pension benefits, etc. based on the amounts equivalent to lump-sum withdrawal payments (early seceding) and dividends of residual assets (dissolution and termination) transferred to PFA in or after October 2005. They are pension liabilities consisting only of a portable portion without a subrogated portion. The planned investment return is in the range of 2%, which means conducting investment with a portfolio that will yield an expected return higher than this. The policy asset mix is a portfolio that can achieve an expected return in the 2% range with the lowest risk.
Since there is no subrogated portion in Portable Corporate Pensions, unlike Basic Pension, there is no need to hedge a portion of the pension liabilities and no change in the required return of the portable portion when translated to the total assets. Although our aim is to invest the total assets to achieve higher than the planned return, the portfolio will not be as high risk in the first place, as the planned interest rate level is lower than that of the Basic Pension (the ratio of risk assets (equities) of the Basic Pension is between 40% and 50%, whereas that of Portable Corporate Pension is 20%).
For Portable Corporate Pensions, the effect of risk adjustment by dynamic management due to changes in the funding ratio is much more limited than in the case of Basic Pension. For this reason, we do not implement dynamic management, opting instead to manage the portfolio in a way that keeps the risk volume at a certain level, while maintaining the policy asset mix as much as possible in our goal of achieving sound finances.

PFA employs quantitative analysis for the formulation of policy asset mix, adopting the downside-risk model for the quantitative model. Downside risk is the risk of the target falling below a certain threshold. PFA defines downside risk as the risk that the funding ratio will fall below 100% and the risk that the return of the portfolio of the portable portion will fall below the target return (planned interest rate). We use the downside-risk model to arrive at a portfolio (asset allocation) that will minimize downside risk.
We also use ALM analysis to estimate a large number of statistically probable future assets and pension liabilities for the candidate portfolios, confirming changes in the distribution of funding status.
In these quantitative analyses, we perform future simulations based on the expected returns of each asset class and a large number of returns using historical distributions.

Expected returns, etc. of each asset class

Using monthly market returns from fiscal 1985 as the return data of each asset class for qualitative analysis, such as analyses of downside-risk model and ALM, we adjust the average return for each asset class to be the expected return and generate 10,000 return data points at random over 10 years or 5 blocks (taking 24 consecutive months as 1 block) (moving block bootstrap (MBB) method).

Although quantitative analysis will produce the correct answers as long as the analysis is based on the assumption that the data entered into the model is accurate, there is no guarantee that the data entered is completely accurate. Accordingly, rather than using the results of the model as they are, we add qualitative judgements to the results to determine the final policy asset mix.
PFA manages massive pension assets worth in excess of 10 trillion yen. We take this scale of assets into particular consideration when making qualitative judgements. A large asset size has many advantages because of the benefit of economies of scale. However, when buying and selling assets, there is a risk that PFA's own transactions will move prices in an unfavorable direction (market impact). A policy that implements rebalancing of asset allocations in accordance with funding ratios will require a careful response to such market impact. As such, we use qualitative judgments to make adjustments to avoid market impact whenever possible, while taking the results of modelling into account.

Before finalizing the policy asset mix in accordance with funding ratios, we confirm the extent to which funding ratios will deteriorate in the event of a major market disruption and the extent to which a market crash can be tolerated. This action is known as a stress test.
In our stress testing, we simulate the extent to which the funding ratio will deteriorate in a major disruption, both of the kind that has occurred in the past and the kind that has never occurred, to check their durability against downside risk.

To ensure the effectiveness of the policy of policy asset mix commensurate with funding ratio, PFA keeps track of funding ratios and asset composition ratios of the previous day on a daily basis and adjust the asset allocations as necessary. This action is known as rebalancing. Rebalancing is designed to adjust asset allocations within a certain range, as the asset composition ratios of actual portfolios change with market fluctuation.
Given the size of PFA's funds, even a small adjustment of ratios would result in a considerable volume of trading, and therefore it is not realistic to execute rebalancing in a single day. To conduct smooth rebalancing while avoiding market impact, we need to handle the situation swiftly in a timely manner and implement it as soon as possible when the necessity arises. To this end, we monitor the situation on a daily basis and execute the necessary rebalancing in a flexible and nimble manner, taking full advantage of in-house investment.

＜Reference 1＞Specific Analysis Method of Downside-Risk Model

• PFA employs a simulation-based downside-risk model using the framework of ALM analysis.
• Ten years of returns are generated as models for future return data from 10,000 different data points. Based on this return data, we calculate the returns of a total of 100,000 portfolios, as well as assets, liabilities, and funding ratios from the future cash flows (multiple time periods).
• If the returns or the funding ratios of the 100,000 portfolios exceed the threshold, they are considered "0," and if they fall below the threshold, the difference is squared. Optimization calculation is then performed to obtain the portfolio with the smallest average (of the squared difference above), in the 100,000 portfolios.
• Return data is generated with the moving block bootstrap method, using the distribution of historical data to reflect the effects of fat-tailed distribution and serial correlation.

＜Reference 2＞Past Policy Asset Mixes

Since April 1996, PFA has formulated its policy asset mixes according to risk tolerance and conducted rebalancing, verification, and revision of those mixes at its own risk and discretion. Before then, there were regulations on asset mix (safety assets: 50% or more, equities: 30% or less, foreign-currency-denominated assets: 30% or less, real estate: 20% or less), which limited PFA's room to determine asset allocations of its own accord.