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On Thursday, October 11, 2007, the Center on Japanese Economy and Business and the Japan Business Association of Columbia Business School cosponsored a zadankai (roundtable discussion) entitled “Issues in Japanese Pension Fund Management” with Mr. Noboru Yamaguchi, Senior Executive Advisor, Fiduciary Service Research Center, Nomura Securities. Speaking before a group of about twenty-five students, faculty, and visiting fellows, Mr. Yamaguchi described the current difficulties faced by most Japanese corporate pension plans. In particular, he noted the low rates of return on corporate pension assets, the lack of professional asset managers, and the need for more diversification in corporate pension portfolios.
Over the past decade, public attention in Japan has become increasingly focused on the funding shortfalls in many corporate pension systems. Like many of their American counterparts, Japanese companies have underfunded their pension programs for years, but recent changes in the law forced them to face the low funding ratios. The funding shortfall is particularly serious because the number of retirees receiving payments will increase rapidly as more of the baby boomers reach retirement age. According to Mr. Yamaguchi, average returns for the past twenty years have been about 4.10 per annum. The figure is even lower for the past ten years—3.44.
One reason for the low rates of return is the conservative investment strategy followed by many corporate pension managers. During the bubble era of the 1980’s, many corporate pension funds invested heavily in real estate. When the bubble burst, the funds suffered huge losses and switched to a more conservative strategy, investing heavily in domestic bonds and securities. Because of the long period of economic malaise in Japan, the returns on these assets have been limited. Now, fund managers are gradually moving to place a greater percentage of their assets in higher return investments.
Another reason for the low rates of return is the lack of professional asset managers. Most corporate pensions in Japan are managed in-house by employees in the human resources department. Most of them have little, if any, finance background. And since company employees in Japan rotate positions every few years, companies fail to develop employees with the skills necessary to manage an investment portfolio. Most corporate pension funds are small (75 have assets under 30 billion yen or $260 million), and companies usually dedicate only one position to fund management.
To cope with the rising liabilities and the funding shortfalls faced by their pension programs, Japanese companies are gradually shifting from a “defined benefit” system to a “defined contribution” system. Under a defined benefit system, retirees are promised a certain level of income throughout their retirement. Most companies have traditionally offered this type of pension plan. In contrast, a defined contribution system does not guarantee a certain income upon retirement. These programs are similar to the 401(K) programs available at many U.S. companies and allow companies to control future liabilities.
Recent changes in the accounting law also present challenges to Japanese companies. Under new accounting standards, companies must record profits and losses on their pension assets on the balance sheet. Volatile returns on their investments can create a headache for companies because the returns are reflected on the bottom line. According to Mr. Yamaguchi, company executives aim for steady, predictable growth on pension fund assets to avoid undue influence on the balance sheet. These new accounting changes are also behind many of the decisions to switch from a defined benefit system to a defined contribution system.
For the future, Mr. Yamaguchi suggested a change in the tax code and greater asset diversification are needed. The current tax benefits from pension contributions are limited, and Japanese employees would gain if the amount of the tax deduction were increased. He also called on fund managers to diversify their portfolios and become more global in their investment strategies. Future changes to investment strategy must balance the inherent risk-averse nature of plan sponsors with the need for higher returns to fund rising future obligations.