Two years ago, Japan Post Insurance, the life insurance arm of the postal giant Japan Post Holdings, joined the growing bandwagon of Japanese institutional investors preparing to make their overseas alternative investment debut by launching an alternative assets division.
The move was followed by the appointment of industry veteran Tadasu Matsuo, formerly the head of Daido Life’s alternative investment operations, to oversee Japan Post Insurance’s push into real estate, infrastructure, private equity and hedge funds investing. That push has been ambitious to say the least: as per a three-year policy plan created in April 2018, the firm is planning to invest 1.5 percent of its $700 billion in total assets under management into alternative investments over the next three years. PERE interviewed Matsuo at the annual investor forum in Tokyo to hear more about this ambitious investment roadmap. Here is an abridged version of the conversation:
PERE: Why is now the right time for Japan Post Insurance and its peers to be embarking on an aggressive overseas alternative investment strategy?
Tadasu Matsuo: When I joined [Japan Post Insurance] almost two years ago there weren’t any alternative investments. We have just started investing in alternative assets within the last year due to economic conditions, including the negative interest rate of the Japanese government bonds.
As a life insurance company, our liability is long term and we guarantee almost 2 percent yield to our policy holders. So, we have to earn investment returns. As a result, Japan Post Insurance and other institutional investors in Japan have had to diversify their investment portfolio so they can earn a sizeable rate of return.
PERE: $10 billion is a tremendous amount of capital to invest within a three-year timeframe. Doesn’t it create excessive pressure for you?
TM: Yes, not only outside pressure, but the internal pressure is also so harsh. However, I think this is not uncommon for Japanese institutional investors like us. Doing a new thing is not an easy task, but we have to because the market environment is so harsh for earning investment returns.
PERE: Given your decades of industry experience, what kind of investing discipline are you urging your team to follow, as you go about making these alternative investments?
TM: My investment philosophy for alternatives is diversification. There should be diversification of vintage, diversification of geography, diversification of asset classes and diversification of managers.
As a life insurance company, we have a long-term AUM structure, so we have a 13- to 14-year average life of liabilities. We have some room to absorb the liquidity risk of making investments. In other words, we do not have to rush to accumulate assets in the short term. Instead, we should diversify the vintage with a step-by-step approach. Maybe in 10 years’ time we will make an optimal portfolio of alternative assets.
PERE: You have adopted a similar investment approach to GPIF in terms of appointing a gatekeeper to assist in deploying capital. Can you talk about the reasoning behind this strategy?
TM: We have no experience of making alternative investments, neither in our investment team or our risk management team. Hence a step-by-step approach is appropriate for a very conservative institution like ours to start a new thing. In the first stage, maybe for the next couple of years, we will work with third-party advisors and gatekeepers to make fund investments. I hope the second stage will start in two to three years from now, when we can gradually start to make direct fund investments, once our team expands and our total alternative investments experience accumulates to a certain level.
PERE: Walk us through the internal decision-making process at Japan Post Insurance. When you are evaluating a potential gatekeeper and subsequent investments, how long does the whole process typically take?
TM: The philosophy to choose a gatekeeper or advisor is [to do so with] transparency. Normally, we ask two to four candidates to submit a request for proposal. After receiving the RFP, we communicate internally to choose an advisor for a certain mandate. But the process takes about two or three months. After choosing the one potential candidate, we negotiate the terms and the mandate in detail, so that takes another couple of months. So, in total, half a year is required to select new gatekeepers for a certain investment. It is not short, but not so long either, considering the nature of an institution like us.
PERE: Japanese investors are typically known in the global real estate industry as cautious investors that take a long time to make a decision. Do you believe this approach may result in missed opportunities, especially when managers are looking to raise capital within a specified duration?
TM: It is true, but once we start investing in alternative investments, we will continue committing capital for a long term and with a sizable amount of budget. The first stage does take more time as compared to overseas institutional investors, but once we have a contract with gatekeepers and partners, these will be long-term partnerships.
PERE: Talking specifically about real estate investments, what are Japan Post Insurance’s target sectors, strategies and geographies?
TM: Domestically we diversify our real estate investments between the J-REITs, private REITs and private real estate fund investments. The main reason for allocating to domestic real estate fund investments is to earn annual dividend income to mitigate the J-curve effect. We also expect a certain level of annual cash-return dividend income from our real estate fund investments overseas. In the next couple of years, we will invest in overseas core and core-plus open-ended real funds so that we can earn not only total income but also an annual sizable cash return.
PERE: What are your return targets from alternative investments and how does that align with Japan Post Insurance’s overall portfolio return expectations?
TM: We do not disclose target portfolio returns. As for alternative investments, sacrificing a certain level of illiquid risk means that we also expect an illiquid premium for doing these investments. So, 6 to 10 percent is the natural outcome, but it also depends on the risk-return profile of the investments. We do not expect 12 to 20 percent returns from core open-ended real estate fund investments in the US or Europe as of today.
PERE: But, once you factor in hedging costs, taxes and all other costs associated with investing outside your home market, is it still worth investing overseas from a risk and return standpoint?
TM: Currency hedging cost is another headache for us. But alternative investments require a long-term perspective as well as a certain buffer of illiquid risk. As a matter of fact, we do not hedge real estate fund, private equity or infrastructure investments because we have not had a legacy portfolio of alternatives assets. So, we can absorb the currency risk to a certain degree. And in addition to that, we believe diversification of asset classes or vintage will give a natural hedging effect to a certain degree.
PERE: What is the size of your investment team currently?
TM: We set up our alternative investment office this April. We started with eight investment professionals and now we have 12 people. These professionals not only cover real estate fund investments, both domestic and globally, but also manage the global mandates for private equity, infrastructure equity and hedge funds. We have to increase the size of the team and, like GPIF, we are looking also to hire more alternative investment professionals.
PERE: Industry observers say one of the biggest recruitment challenges faced by Japanese institutional investors, especially public institutions, is the less competitive pay offered when compared with private companies. Do you agree?
TM: Compensation is always one of the issues for recruitment, since an institution like ours cannot pay a huge salary. But having said so, we just started investing in alternatives with a long-term perspective. And because of the size of our AUM and longer-term plan for accumulating alternative assets, making a career in the alternatives field while working for a company like ours is not necessarily a bad choice, I believe. I am aiming to increase the headcount of the investment team to up to 20 in a year or two, hopefully.
PERE: In your view, what are the biggest risks currently facing Japanese investors as they make their overseas debut?
TM: Once an institutional investor like us starts investing in alternatives, we must continue committing to the asset classes, whether the market is good or bad. We learned our lesson through the global financial crisis. The winners of that turbulence in the market were those who continued investing and committing to the asset classes in the last five to ten years. The biggest risk is to stop investing in alternatives once you have started. However, it is easier said than done to keep doing so.