FTSE Russell awaits pivotal GPIF decision on flagship bond index

Japan’s Government Pension Investment Fund said it would decide in the coming months whether to continue to invest via the FTSE Russell’s flagship bond index, a resolution that could affect billions in assets tracking the index.

FTSE Russell confirmed on March 31 that Chinese government bonds would be included in its World Government Bond Index (WGBI), despite reportedly facing objections to its plan from Japanese investors.

Their resistance to China debt inclusion is of vital importance to FTSE Russell because Japanese investors are heavy users of the WGBI. Although there is no concrete data, it has been estimated that they could represent as much as 80 per cent of funds pegged to the index, which is currently tracked by roughly $2.5tn of assets, according to Nomura.

In a December meeting with the index provider, GPIF and other Japanese investors tried to resist the move, mostly due to technical concerns such as liquidity, settlement issues and foreign exchange risks that are not specific to the Chinese market.

But there were also concerns about historical tensions between the two countries, Reuters reported in January.

Atsuhito Mori, Tokyo-based head of the asset management department at Orix Bank, noted that the GPIF might also be worried about falling short of its own disclosure requirements.

“Japanese pension funds, including the GPIF, have to disclose their risks and the reasons behind their investments, but the Chinese government and some local companies may not be so open to disclose what they are doing. Because of that, the GPIF may also have a disclosure problem to its own fiduciaries,” he said.

Concerns from foreign market players about the inclusion of Chinese debt in the WGBI, including those from Japanese investors, has already prompted FTSE Russell to extend the period during which the Chinese bonds would be included from its original target of one year to three years.

The GPIF, the world’s largest pension fund that controlled ¥177.7tn ($1.63tn) in assets at the end of last year, told Ignites Asia that it had no investments in onshore Chinese government bonds at the moment because of Chinese restrictions on foreign investors.

I don’t think the GPIF has any reason not to invest in Chinese government bonds any more . . . if there is one, it will have to be a very unique political reason, but that will be very difficult to justify

But the GPIF added that, now that FTSE Russell made the move, it would consider its response in the months to come.

The inclusion process will kick off on October 29. By the time it is completed, some 47 Chinese government bonds will collectively bring in approximately $131.2bn of foreign inflows into Chinese onshore government bonds, according to a research note from Nomura published on April 1.

Despite concerns about risks associated with Chinese onshore bonds, some market participants said that FTSE Russell’s decision added credibility to the Chinese securities and that the time was ripe for Japanese investors, led by the GPIF, to take the plunge.

“I don’t think the GPIF has any reason not to invest in Chinese government bonds any more,” said Orix Bank’s Mori.

“If there is one, it will have to be a very unique political reason, but that will be very difficult to justify,” he said.

Mori’s view is echoed by an executive at a Tokyo-based consulting firm, who added that GPIF’s decision to invest in Chinese bonds would be a “watershed” moment for Japanese pension funds because institutional investors tend to “move in tandem in Japan” — Japan’s pension funds, financial institutions and retail investors all look to the GPIF.

Orix Bank’s Mori said that while some pension funds may have indirectly bought Chinese domestic bonds through Hong Kong, Singapore and other markets, rarely had they directly participated in the Chinese local bond market.

“Pension funds have fiduciary responsibilities and so they may have stricter criteria on whether or not to invest in Chinese bonds. But for them, if the GPIF ends up investing in Chinese government bonds, they will as well,” he added.

Although Japanese financial institutions, such as commercial banks and insurers, are usually conservative, many have also been forced to increase their risk appetite due to the country’s chronic low-yield environment.

Chinese government bonds offer comparatively attractive yields. China’s 10-year sovereign bonds were yielding about 3.24 per cent on April 9, well above the 0.1 per cent yield for Japanese 10-year sovereign bonds and 1.64 per cent for 10-year US Treasuries.

When Chinese sovereign bonds are included in the WGBI, they will offer the third-highest yield in the index, below Mexico and Malaysia’s yields but significantly higher than that of the US, Japan and Germany, according to research from AXA Investment Managers.

Hiroshi Tanaka, general manager of Sumitomo Mitsui DS Asset Management’s institutional marketing department, said more Japanese institutions were considering exposure to Chinese domestic bonds to benefit from the higher yields and low correlation to other asset classes.

However, some were still shunning Chinese bonds because of concerns including geopolitical, liquidity and regulatory risks, such as sudden changes in capital control rules, he said.

Potential geopolitical risks revolve around the intensifying rivalry between the US and China, especially in the technology sector. Chinese corporate bond issuers may also be caught between China and the US over human rights issues, which could potentially disrupt their daily business.

“Some Japanese investors [of] investment-grade, dollar-denominated China offshore corporate bonds are cautious that the US executive orders prohibiting investment in certain Chinese companies could affect liquidity,” said Takahiro Tazaki, global head of product specialists at Nikko Asset Management.

Nevertheless, Tazaki said appetite for Chinese bonds had picked up among Japanese investors, especially banks and life insurance companies, but they mainly invested in Chinese government bonds and policy bank bonds as opposed to the less-liquid and riskier domestic corporate bonds.

That same preference applies to most overseas investors. Foreign investors owned Rmb3.14tn ($479.2bn), or 4.13 per cent, of Chinese domestic bonds as of March, according to data from China Central Depository & Clearing. Nearly 97 per cent of that sum was invested in government debt and policy bank bonds.