On His Shoulders, a Graying Japan
By KEN BELSON
okyo
YOU would never know by looking at Noboru Terada that he helps manage the world's largest pension fund. Diminutive, graying and no-nonsense, he looks more like an ordinary middle manager than someone in charge of 31.6 trillion yen (about $283 billion).
Mr. Terada, the executive investment officer of the Government Pension Investment Fund, is arguably Japan's most influential investor, overseeing the nation's vast retirement piggy bank. Largely hidden from the public, he also has one of the most difficult jobs in Japan: raising investment returns to keep the national pension system from collapsing.
After years of rising payouts, interest rates near zero and falling stock prices, Japan's pension plans are deeply in the red. Faith in the system is so weak that a staggering 37 percent of self-employed workers do not pay their premiums, which could leave them without benefits. Yet the government must prepare for waves of baby boomers nearing retirement. Politicians, reluctant to alienate voters, have only trimmed benefits and nudged premiums higher.
Though the United States and other countries face similar demographic problems, Japan's pension situation is one of the worst cases because of the size of the deficits and the graying of the population. And while many other countries have had an inflow of younger immigrants, who have been replenishing tax rolls and pension plans, Japan has not.
The hesitancy of policy makers in Japan to find solutions to these immense problems has put the spotlight on Mr. Terada. Under pressure to generate large-enough profits to offset the yawning gap in the plan's budget, he has imported new investment techniques, like indexing, and broken with the local custom by rewarding better-performing - not better-connected - investment managers.
By modernizing Japan's pension system, he hopes to increase returns and reassure the public.
"Many people wonder about the direction of the pension system, but we want them to have confidence," said Mr. Terada, who carries stacks of papers like an absent-minded professor. "The aging society is a very significant problem we have to face. If we can enhance our returns, the burden on the Japanese people will be reduced."
Many of Mr. Terada's tactics were introduced decades ago in the United States. But they have shaken Japan's trust banks and life insurers, whose cozy relations with the government long protected them from competition. They have also been a boon for foreign fund managers who specialize in quantitative products like enhanced indexing, which promises to outperform an index with little extra risk or cost.
His performance-based agenda is groundbreaking in Japan, especially in a public organization.
Mr. Terada, who is 67 and has worked in the field for more than three decades, started his career at Nomura Securities, Japan's largest broker. In the mid-1960's, he moved to the company's research arm, the Nomura Research Institute. During that time, he spent a year at the University of Chicago's Center for Research in Security Prices, where he learned the latest methods of evaluating risk and maximizing returns.
Since then, he has focused on pension funds and Japan's looming demographic problems. Through Mr. Terada's growing connections overseas, he introduced to Japan the ways to measure volatility called beta coefficients. Writing in journals, he explained the latest innovations incorporated into the Employee Retirement Income Security Act, or Erisa, of the United States to fund managers who knew little about fiduciary responsibility.
"I was deeply influenced by his papers in the 1970's," said Takahide Mizuno, now the chief investment officer at the Nomura Asset Management Company. "Terada was the first person to introduce modern portfolio theory into Japan."
STILL, with Japan's stock market and economy booming in the 1980's, few people paid attention to Mr. Terada's warnings, even after he took on a more prominent role as director of the Pension Fund Association. But in the 1990's, as stock prices and interest rates tumbled and the financial industry was deregulated, local fund managers had to heed his warnings to improve or lose out to foreigners and their newfangled investment methods.
"Terada's like Nostradamus: whatever he said has come true," said Tomomi Yano, executive managing director of the Pension Fund Association. "Most fund managers only care about getting their contracts renewed. But Terada has consistently been able to see the future."
Mr. Terada took his vision to an even bigger audience in April 2001. That was when the government broke up Nempuku, the Government Pension Investment Fund's predecessor, which was tightly controlled by the Finance Ministry. With the government's debt exploding and the pension plan's finances in disarray, policy makers needed to raise returns or face a financial catastrophe.
So they created the pension investment fund and gave it the ability to invest as it liked, freeing it from the strict guidelines that limited Nempuku's creativity - and returns. Mr. Terada took this mandate to heart. Careful study had shown him that passively managed funds that tracked indexes not only charged lower administrative fees, but also outperformed the funds that actively picked stocks and bonds.
Armed with that knowledge, the Government Pension Investment Fund shifted trillions of yen into passive funds. More than 70 percent of its investments in Japanese stocks are now managed this way, nearly three times as many as in 2000. Nearly 80 percent of the fund's money in foreign stocks and bonds is managed this way as well.
The results were immediate. The fund cut the amount of management fees it paid by 57 percent, to $153 million, in just two years.
Under Mr. Terada, the Government Pension Investment Fund also threw open the process for choosing and evaluating fund managers. Fund mandates are now solicited online, and the results are posted on the pension investment fund's Web site. The performance of each money manager is ranked and compared with the market average; those numbers are also available online. The site even lists the amount of fees it pays to each investment manager.
The Government Pension Investment Fund "has set the trend for the whole market when it comes to corporate governance and returns," said Mark J. Lazberger, president and chief executive of State Street Japan, which has $30 billion of assets under management in Japan.
"Terada's one of the very few people bringing about change in the fund management industry," he added.
While foreigners celebrated the more liberal disclosure policy, the local asset managers who had been chosen primarily for their relationship to Japan's powerful banks and their business partners were less pleased. "There used to be a very under-the-table approach to why someone was hired and fired," said one Japanese asset manager with decades of experience in the industry.
In a very un-Japanese way, the clear-cut, public benchmarks allowed the pension investment fund to cut the number of asset managers, to 70 from 91 last year alone. Not all of those let go were Japanese; foreign investment advisers were dumped, too. But Japanese firms with less sophisticated skills were hit hardest.
"Japanese investment firms are not as competitive," said Mr. Terada, who has publicly chastised Japanese fund managers for failing to give up their old business practices. "They don't compete on returns and new investments. They rely on their strong relationships with their "keiretsu,' '' or corporate groups.
Mr. Terada's forthrightness has not gone unnoticed. To increase returns, the Government Pension Investment Fund has increased the amount it invests in equities and in assets overseas. Unfortunately, the Nikkei 225 slid about 40 percent in the two years after April 2001. The fund's stock portfolio, domestic and foreign, lost 3.5 trillion yen ($31 billion) in the year that ended in March 2003. Politicians were livid and took aim at Mr. Terada's tactics.
Despite the red ink and bad blood, the fund's losses were largely in line with public funds outside Japan, according to Wilshire Associates' Trust Universe Comparison Service.
Moreover, the pension investment fund's strategy of buying stocks in a falling market turned out to be shrewd: the Nikkei 225 has risen 35 percent since April. Instead of being concerned about individual stocks and industries, Mr. Terada pays attention to producing needed returns. To that end, he is studying whether to invest in real estate, hedge funds and other alternative investments.
The question is not only whether Mr. Terada's moves can produce the return of 4.5 percent that is the target of the pension investment fund, but also whether they will be enough to cover the decline in workers' contributions and the rising payouts that retirees demand. Policy makers have endlessly debated the issues, and few of the proposed solutions are expected to solve the problems.
"The Koizumi cabinet has a time bomb - the national pension plan - and no one wants to touch it," said Kunji Okue, an economist at Dresdner Kleinwort Wasserstein, referring to Prime Minister Junichiro Koizumi. "If I were Terada, I wouldn't take that job."
Mr. Okue estimates that the pension investment fund will run cumulative deficits worth 27 trillion yen over the next five years because interest rates are so low. That would force the government to dig deeper into the fund's reserves to meet its pension obligations. That may not come about, of course, if Japan's stock market and bond yields keep rising and the economy truly recovers.
REGARDLESS, the investment fund will play an increasingly prominent role in the world's financial markets in coming years.
The pension investment fund is expected to manage 97.2 trillion yen ($870 billion), more than the economy of Canada, by March 2009. Of that pool, 11.6 trillion yen ($103 billion ) will be invested in foreign stock markets.
That should make the fund an even more formidable player on Wall Street, and in other major markets, and make Mr. Terada's policies that much more relevant to the world beyond Japan.
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