1) Significant yen weakness and massive expansion of the Bank of Japan's balance sheet provide strong earnings support for Japanese equities in 2015 and beyond 2016. 2) Slow but accelerating inflation in Japan means Japanese government bond yields can only move upward over the next 12 months. 3) The Bank of Japan's large-scale purchases of assets like equities and government bonds are intended to stimulate the Japanese economy and inflation, but also risk continued downward pressure on the yen.

1. αβχ
Global Research
Significant yen weakness plants strong earnings momentum behind
Japanese equities in 2015 while massive expansion of the BoJ’s
balance sheet suggests this trend continues beyond 2016. Slow but
accelerating inflation means JGB yields can only move up.
After repeated attempts and failures at fighting deflation and tackling structural reform,
Japanese policymakers have finally grasped the mantle of policy reform with both hands.
However, the speed and scale of what is now required to solve Japan’s ills is far greater
than what would otherwise have been the case. The upshot is a massive expansion of the
Bank of Japan’s (BoJ) balance sheet, which has significant implications for financial
markets, inflation and real wage growth. For investors, this means staying Overweight
Japanese equities and Underweight Japanese Government Bonds (JGBs) beyond 2015.
The first major tailwind for domestic equities comes from the BoJ’s revised Quantitative
and Qualitative Monetary Easing (QQE) policy announced last October. This commits the
BoJ to an accelerated pace of purchasing domestic equities for as long as necessary to
reach its 2% inflation target. After accumulating 5tn yen ($40bn) worth of Japanese equity
ETFs since the end of 2010, these purchases have been running at a 3tn yen annualised
pace YTD. While the timeframe for future purchases remains open-ended, so too is the
period in which the sale of these assets is likely to take place. As of last month, the BoJ
still holds two-thirds of the 2tn yen of equities it has purchased from the banks since 2002.
The second major support for Japanese equities comes from the Government Pension
Investment Fund (GPIF), which is the world’s biggest pension fund and manages assets
worth 123tn yen ($1tn) as of end-2014, equivalent to ¼ of Japan’s GDP. The changes,
which have already partly been implemented since last October’s announcement, involves
as much as two-thirds cut in target bond holdings and as much as doubling the target
equity exposure. This leaves the GPIF with as much as an estimated 14.6tn yen of dry
powder left for equity purchases as of end-June (equivalent to 7 days of trading volume).
The third key support for Japanese stocks has been downward pressure on the Japanese
yen, a trend which is likely to continue beyond 2016 given the BoJ’s balance sheet
expansion is now much faster than the US Federal Reserve. This should help ensure
continued earnings support for the rest of the year, helping to keep valuations in check.
The final reason to stay bullish Japanese equities is the diminishing appeal of JGBs,
despite the BoJ’s annualised 80tn of JGB purchases ensuring any rise in yields would be
slow. The recent improvement in real wage growth points to slow but accelerating
inflation as well as higher bond yields over the next 12 months. The asset class remains
less favoured relative to equities and should remain Underweight in 2015 and 2016.
Wesley Fogel
Investment Strategist
+44 7860 264 902
fogel@hotmail.com
18 June 2015 Asset Allocation
Global
Navigator
Error and trial
Asset Allocation

2. αβχ
Japan has faced some of the biggest social and
economic challenges anywhere in the world for the
better part of 25 years. Unfortunately for investors,
and the Japanese, a persistent lack of domestic
political will and insufficiently bold economic
policies have left many of the country’s major
structural problems to fester. As a consequence, the
speed and scale of any future efforts aimed at tackling
Japan’s long-term challenges will need to be far
greater than would otherwise have been the case.
In some aspects, the latest response from Japan’s
policymakers has been extraordinary, in others less
so. In its assessment of Japan’s economy last July, the
International Monetary Fund (IMF) concluded that,
while Abenomics is gaining traction, progress across
the “three arrows” has been uneven and sees
substantial medium-term risks.
The key concerns highlighted were the slow pace of
structural reforms and the lack of specifics for a
medium-term fiscal plan beyond 2015. Without these,
the IMF believes it is unclear if Japan’s recovery and
exit from deflation can be sustained.
Since last summer Japan has moved two big steps
forward. The first is Shinzo Abe’s re-election,
breaking the country’s habit of changing PM each
year since 2006 (when Abe was last in power).
Second is the Bank of Japan (BoJ) tripling the pace of
its planned purchases of Japanese equity ETFs to 3tn
yen a year (equivalent to 1 day of trading volume for
the Topix Index with more than 1,800 constituents).
However, the country has also moved two steps
backwards, first with the next hike in VAT from 8%
to 10% now being delayed until at least April 2017
and second, inflation excluding fresh food and net of
last year’s sales-tax increase, slowing back to 0%.
Underpinning much of the progress that has been
made in recent years has been a massive increase in
the BoJ’s balance sheet, to 345tn yen ($2.8tn) from
175tn yen since the start of Quantitative and
Qualitative Monetary Easing (QQE) in April 2013.
A direct consequence of this unprecedented policy
action has been the debasement of the Japanese yen,
which has been the third-worst-performing major
currency since the end-September 2012 (up until last
November, the yen had even managed to
underperform the Russian ruble). Chart 1 shows how
the growth in the BoJ’s balance sheet relative to the
Chart 1. BoJ’s aggressive balance sheet expansion should
lead to a weaker JPY over the next 24 months
75
85
95
105
115
125
135
145
155
Feb-01 Feb-05 Feb-09 Feb-13 Feb-17
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
USD per JPY
BoJ/Fed balance sheet, YoY differential, LAGGED 24m (rhs)
Source: Bloomberg, Author’s calculations
Error and trial
Significant yen weakness gives equities strong earnings support
BoJ balance sheet expansion means this trend continues in 2016
Slow but accelerating inflation means bond yields only move up

3. αβχ
U.S. Federal Reserve leads the yen by around two
years. This suggests that downward pressure on the
yen is likely to remain until well into 2017.
Japanese policymakers will therefore face a growing
dilemma of helping to stimulate the domestic
economy while avoiding a currency war with its main
trading partners (China, the US and the rest of Asia).
The difficulty of striking this balance recently
became evident when current BoJ Governor Haruhiko
Kuroda recently stated that “the yen is unlikely to
weaken further in real effective terms if you think
with common sense, given how far it has come.”
Kuroda was then forced to retract his earlier comment
by adding a few days later: “I didn’t say that I’m not
seeking a weak yen in nominal terms, nor did I say
that it’s unlikely that the yen will fall further.”
Chart 2 illustrates how much faster Japan’s real
effective exchange rate has weakened vs. the US
dollar compared with the nominal rate given the
persistence of deflation or much slower inflation in
Japan compared with the rest of the world, over much
of the period. While the yen’s ‘stealth’ devaluation
has not made headlines, it does show how pressing
Japan’s need to start to generate inflation is in order
to avoid distorting the currency market even further
than it has done since the start of QQE.
Chart 2. The real effective Japanese exchange rate has
weakened much faster than the nominal rate with deflation
0
20
40
60
80
100
120
140
Jan-71 Jan-82 Jan-93 Jan-04 Jan-15
USD per JPY (nominal)
USD per JPY (real)
WeakerJPY
Source: JPMorgan, Bloomberg, Author’s calculations
Given a chequered history of false starts and mis-
timed policy measures, Japanese authorities will be
reluctant to repeat the same mistakes. This should
ensure a commitment to policy stimulus at a scale
that would have once been considered damaging to
the credibility of either the government or the BoJ.
As a result, such policy actions will likely remain a
key driver of asset prices in Japan for the coming
years. This report aims to identify the appropriate
asset allocate strategy in an environment of
extraordinary change in the attitude of Japanese
policymakers towards tackling many of its long-term
economic challenges.
Japanese equity: turbo-charged
The performance of the Japanese stock market has
effectively become one of the government’s preferred
metrics by which to judge the success of its reform
agenda. While this is music to the ears of equity
investors, doubts remain about the long-term
sustainability of pursuing such a strategy.
Before the BoJ started actively buying Japanese
equities, first from the struggling banks in 2002/4 and
again in 2009/10 as well as more recently through
outright purchases of equity exchange traded funds
(ETFs), it was well aware of the potential risks from
executing such a strategy. In particular concerns were
focused on the ability to unwind such a policy.
Chart 3. BoJ actively buying Japanese equities since 2002
40
50
60
70
80
90
100
110
Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Jan-14
10%
20%
30%
40%
50%
60%
Topix rel. to ACWI (US$)
Topix rel. to ACWI (local)
BoJ holdings of Japanese equity ETFs, YoY (rhs)
BoJ buys 2tn yen
of equities from banks
BoJ buys 387bn yen
of equities from banks
Source: Bank of Japan, Bloomberg, Author’s calculations
In a December 1998 speech (still two months before
the BoJ had even begun with its zero interest rate
policy or ZIRP), the late Governor Masaru Hayami
expressed concerns about the potential for “long-term
fixing of assets on the Bank's balance sheet” were it
to take on private-sector risk. In effect, the potentially

4. αβχ
destabilising effects of selling down equities would
lead such assets to remain on its balance sheet for an
extended period of time.
After eventually going down the path of buying
equities, one of key reasons behind the BoJ’s initial
reluctance to pursue such a policy has so far proven
correct. As of last month, the BoJ still holds two-
thirds of the 2tn yen of equities it has purchased from
the banks since 2002 (currently valued at 1.35tn yen
or $11bn). This is in addition to the 5tn yen of
Japanese ETFs that have been accumulated since the
end of 2010 and at a 3tn yen annualised pace YTD.
In December 2013, the BoJ also announced a further
two-year postponement of the date from which it
would re-commence the selling of the first round of
purchased equities due to “recent developments in
domestic and overseas financial markets”. This is
now scheduled to begin at end-March 2016, with a
completion date set for end-September 2021. Note
that before January 2012, the BoJ had initially
planned to start selling equities from end-March 2012
with a completion date of end-September 2017.
It should therefore be informative for equity investors
that the BoJ’s timeframe for the sale of Japanese
equities purchased between 2002-9 has been moved
back by a total of four years within 24 months.
Still a long way to go
While the Topix Index is now 60% higher than when
the BoJ introduced QQE in April 2013, it still
remains 42% below the 1989 bubble peak. Valuations
do not currently looked stretched, with the market
trading on a Bloomberg consensus 12-month forward
P/E of 15.6x compared with 14x at the start of the
year and where the market also stood when QQE was
first announced in 2013. Key to helping valuations
stay in check over this time has been a sustained
improvement in earnings, which are now back to pre-
2008/9 crisis levels (see Chart 4).
Chart 4. Japanese equities have rerated with strong earnings
30
50
70
90
110
130
150
170
Jun-05 Mar-07 Dec-08 Sep-10 Jun-12 Mar-14
8
13
18
23
28
33
38
Topix 12m fwd. EPS (local)
Topix 12m fwd. P/E (rhs)
Source: Bloomberg
A major catalyst behind the most recent earnings
cycle has been a weaker yen, which as mentioned
above, has been substantial compared with other
major crosses. In fact, chart 5 shows how an
accelerating pace of YoY weakening (or slowing in
YoY strengthening) in JPY has consistently led the
Japanese earnings cycle by 6 months over the decade,
suggesting that further potential earnings support
remains for the rest of the year.
Chart 5. JPY/USD leads the Japanese earnings cycle
-80%
-60%
-40%
-20%
0%
20%
40%
60%
80%
100%
120%
Dec-06 Dec-08 Dec-10 Dec-12 Dec-14
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
Topix 12m fwd. EPS
JPY/USD, LAGGED 6m (rhs)
Source: Bloomberg, Author’s calculations
The first cycle upturn, which lasted between March
2009 and February 2011 saw domestically-focused
real estate as well as export-oriented wholesale
distributors, manufacturers and chemical producers
outperform the rest of the market. Real estate was the
only sector to have seen all of its performance driven
by multiple expansion while all others saw earnings
drive the vast majority of gains. Defensive sectors
including healthcare and food & bev as well as the
banks lagged the market (see Chart 6).

5. αβχ
Chart 6. Machinery, Chemicals and Materials saw the biggest
earnings recovery between 2009-2011*
-60%
-40%
-20%
0%
20%
40%
60%
80%
100%
120%
140%
RealEstate
Wholesale
Machinery
Chemicals
Telecoms
Materials
Services
Retail
Construction
Insurance
Food&Bev
Healthcare
Banks
LandTrans
Others
Price return Change in P/E
Earnings growth Dividends
(Annualised between March 12 2009 - February 21 2011)
Source: Bloomberg, Author’s calculations *Transport, Electrical Appliances and
Financials are excluded due to negative earnings in 2009.
Then the combination of a sluggish recovery from the
Fukushima disaster, the strongest yen in 15 years, a
Eurozone debt crisis and China’s anti-Japan protests
conspired to turn what would have been a mid-cycle
slowdown into a full-blown recession. However, with
most of the impact of the yen having already been felt
across corporate Japan, earnings remained broadly
resilient while the market fell 28% in local currency
(-24% in US$) between February 2011 and June 2012
compared with a 16% decline in the MSCI ACWI
over the same period.
During this bear market, the Topix derated from a 12-
month forward P/E of 14x prior to the Fukushima
disaster to around 10x by mid-2012.
Chart 7. A broad-based derating took place following the
2011 Fukushima disaster while earnings mostly held up
-120%
-100%
-80%
-60%
-40%
-20%
0%
20%
40%
Food&Bev
Retail
Construction
Healthcare
LandTrans
Services
Telecoms
Wholesale
Transport
Chemicals
Banks
Machinery
RealEstate
ElecAppl
Insurance
Materials
Others
Financials
Price return Change in P/E
Earnings growth Dividends
(Annualised between February 21 2011 - June 4 2012)
Source: Bloomberg, Author’s calculations
Chart 7 shows how this was a broad-based derating
with 10 out of the 18 biggest sectors (accounting for
90% of market cap) falling by more than 20%.
Financials, Materials and Insurance were the worst-
Chart 8. Cyclicals lead and defensives lag in a QQE world
-20%
0%
20%
40%
60%
80%
100%
120%
Financials
Insurance
Construction
Transport
RealEstate
Telecoms
Services
ElecAppl
Banks
Machinery
Others
Chemicals
Healthcare
LandTrans
Food&Bev
Retail
Materials
Wholesale
Price return Change in P/E
Earnings growth Dividends
(Annualised between June 4 2012 - June 11 2015)
Source: Bloomberg, Author’s calculations
hit parts of the market while Food & Bev, Retail and
Construction all outperformed.
The latest recovery phase has been far more
pronounced than post the 2008/9 financial crisis, with
returns of double the annualised pace since the June
2012 trough. All sectors have seen annualised returns
of more than 20% with most seeing earnings drive at
least two-fifths of the gains.
In addition, the past three years has seen higher
dividend yielding Banks, Insurance and Construction
play a much bigger role in the recovery than
previously. In contrast, Wholesale Distributors and
lower yielding Materials have benefited far less.
Chart 9. Cyclical sectors biggest beneficiaries of weak JPY
30%
35%
40%
45%
50%
55%
60%
65%
Transport
ElectricAppliances
Machinery
Chemicals
Banks
Financials
Wholesale
Insurance
Retail
Materials
RealEstate
Telecoms
Construction
LandTransport
Food&Bev
Services
Healthcare
Since 2009 Since 2013
Correlation with JPY weakness(local currency performance)
Source: Bloomberg, Author’s calculations
Chart 9 shows how all sectors have seen the
correlation with a weaker yen increase over the past
two years compared with the period since 2009.
Banks and Insurance are among those parts of the
market to have seen the biggest increase in

6. αβχ
correlation while infrastructure play Land Transport
remains the most correlated sector.
US recovery a further tailwind
Cyclical sectors should also benefit further from a
continued US recovery into 2016, which is expected
to bring with it higher US bond yields and in turn
create further pressure for yen weakness. Chart 9
shows how Japanese equities have historically been
moved in lock-step with US 2-year yields.
Chart 10. Higher US bond yields have historically been
associated with rising Japanese equities…
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
11%
12%
Jan-90 Jan-94 Jan-98 Jan-02 Jan-06 Jan-10 Jan-14
25
40
55
70
85
100
US 2-year bond yield
Topix (rhs)
Source: Bloomberg
Even as short-end US yields have remained sub-1%
for the past five years, the visible trend higher that
began in mid-2013 has helped underpin the bull
market in Japanese equities over the same period (see
Chart 10).
Chart 10. …and the past two years have been no exception
0.2%
0.3%
0.4%
0.5%
0.6%
0.7%
0.8%
May-13 Nov-13 May-14 Nov-14 May-15
90
100
110
120
130
140
150
US 2-year bond yield
Topix (rhs)
Source: Bloomberg
In large part this relationship is driven by effect on
the yen from the differential between rising US and,
more recently negative, Japanese yields. Chart 11
shows how the 10-year yield differential has led
turning points in JPY since the mid 1990s by around
12 months, adding to the case for further downward
Chart 11. US/Japan 10-yr yield differential leads JPY by 12m
0
50
100
150
200
250
300
350
400
450
500
550
600
650
Nov-93 Mar-97 Jul-00 Nov-03 Mar-07 Jul-10 Nov-13
70
80
90
100
110
120
130
140
US 10-yr/Japan 10-yr yield differential (bp), LAGGED 12m
JPY (rhs)
Source: Bloomberg, Author’s calculations
pressure on the yen going in to 2016. US Treasury
data as of end-April show Japanese holdings of
Treasury securities have risen to around US$1.2tn
from $1.1tn in mid-2013 and $0.5tn in mid-2008.
Conclusion
Unprecedented BoJ stimulus and a wider US/Japan
yield differential will translate into further yen
weakness going into 2016. This will ensure strong
earnings momentum behind Japanese equities, which
should see further rerating going into 2016. Prefer
higher yielding cyclical sectors that stand to benefit
from further yen weakness including banks and
construction as well as insurance and land transport.
JGBs: taking a bull by the horns
Core to the government and BoJ’s strategy of trying
to spark demand for risk assets has been a policy of
Japanese Government Bond (JGB) purchases that
would make former Governor Hayami weep.
In his 1998 speech, Gov. Hayami responded to claims
the Bank should buy more JGBs by highlighting that
holdings of such assets already totalled a “very
substantial” 52tn yen or two-thirds of its balance
sheet. What then might he say to total holdings of
JGBs having now ballooned to 288tn yen from 100tn
yen or from 65% to 84% of the BoJ’s balance sheet in
the space of three years?

7. αβχ
Of course, the need for unconventional policy
measures has now become mainstream thinking
globally as well as in Japan, as even Hayami and the
BoJ later conceded with the introduction of its first
ZIRP from early 1999 (although even this was later
followed by the regrettable decision to hike rates in
August 2000, only to reverse course less than a year
later). Ironically, the challenge now for the BoJ is in
testing the limits of how far it is able to go in order to
generate inflation of 2% over the next two years.
Friendly takeover
The growing importance of the BoJ in the JGB and T-
Bill market, which is 90% domestically held, cannot
be understated. The BoJ currently holds around a
quarter of all outstanding JGBs and T-Bills, a market
valued at just over 1 quadrillion yen (1,000 trillion
yen or US$8tn). This compares with holding 7.5% of
the total in September 2009. Over the same period,
the banks have seen their share fall to 34% from 43%
while the share of public pension funds (discussed in
more detail below) has fallen to 5.6% from 11.7%.
As mentioned above, past inaction from Japanese
authorities has meant that any future actions taken
will need to be more extensive than would otherwise
have been the case. This has significant implications
for both Japanese equity and bond markets.
Chart 12. BoJ holdings of JGBs have ballooned since 2013
50%
55%
60%
65%
70%
75%
80%
85%
90%
Apr-98 Apr-02 Apr-06 Apr-10 Apr-14
Govt securities, % of BoJ balance sheet
Source: Bank of Japan, Author’s calculations
Under the BoJ’s revised QQE plan announced last
October, it will now target annual purchases of JGBs
worth 80 tn yen (vs. 50tn yen initially proposed six
months earlier). To put this into context, the JGB
market was valued at 885tn yen at end-2014 with the
BoJ accounting for 23.4% of the total outstanding.
The amount of Japan’s outstanding general bonds has
grown by 30-40tn yen since 2009. This would imply
that the BoJ is not only using half of its buying power
to consume all new issuance going forward but the
other half to draw down the holdings of all other
domestic players in the market.
The latest Monthly Newsletter from the Ministry of
Finance shows banks as net sellers of long-term JGBs
in two of the past three months to April, continuing a
falling trend of government bond holdings that started
in January 2012. In contrast, foreign buying
continues, although mainly in the shorter end T-Bills
market, which has helped push the share of foreign
holdings of JGBs and T-Bills to a record 9.3%,
double the level from a decade earlier.
Chart 13. BoJ now the second-biggest player in JGB market
43%
20%
12%
8%
6%
5%
4%
3%
1%
35%
22%
7%
23%
5%
2%
4%
1%
0%
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
Banks
Insurance
Public
Pensions
BoJ
Foreigners
Households
Pension
Funds
Others
General
Government
September 2009 December 2014
Breakdown of JGB
Source: Bank of Japan
BoJ’s strategy starting to pay off
The BoJ’s unprecedented stimulus has had some
positive impact on inflation, with the key measure of
CPI All Items less Fresh Food ex Consumption Tax
Hikes accelerating to as much as 1.5% in mid-2014
although this has since moved back to 0% as of April
post the 50% decline in oil prices and weaker

8. αβχ
domestic demand given the rise in VAT. Real wage
growth looks more promising, rising 0.1% YoY in
April, the first increase since April 2013. Chart 14
shows than an accelerating pace of YoY growth in
real wages leads turning points in the inflation cycle
by as much as 24 months. This is currently signalling
slow but accelerating inflation in the coming years.
Chart 14. Accelerating real wage growth = inflation pressure
-800
-600
-400
-200
0
200
400
600
800
1000
Apr-06 Apr-09 Apr-12 Apr-15
-300
-200
-100
0
100
200
300
Japan real wages, 24m ch. in YoY rate LAGGED 24 m
Japan inflation, 24m ch. in YoY rate (rhs)
bp bp
Source: Bloomberg, Author’s calculations
While the BoJ’s massive bond purchases are intended
to lead to a decline in interest rates across the entire
yield curve, the Bank is ultimately using QQE as a
way to achieve the price stability target of 2% over
the next two years. Balancing both objectives will
prove more challenging as inflation expectations
increase over time and the current improvement in
real wage growth points to higher bond yields over
the next 12 months (see Chart 15).
Chart 15. Accelerating real wage growth = higher bond yields
-1000
-800
-600
-400
-200
0
200
400
600
800
1000
Feb-03 Feb-06 Feb-09 Feb-12 Feb-15
-800
-600
-400
-200
0
200
400
600
800
Japan 10-year bond yield, 12m ch. in YoY rate
Japan real wages, 12m ch. in YoY rate (LAGGED 12m)
bp bp
Source: Bloomberg, Author’s calculations
In his speech last month, BoJ Governor Kuroda
highlights that inflation is expected to accelerate to
2% in H1 2016. He also described the policy effects
of QQE as roughly equivalent almost ten 0.25% cuts
in short-term interest rates in one shot under
conventional monetary policy. With inflation
expected to move towards 2% within the next year
and consumer spending supported by accelerating
real wages and a delayed further VAT hike, there is
further evidence to suggest that the next move in
bond yields is most likely to be up.
Conclusion
The BoJ’s massive JGB purchases have ensured that
yields rise slowly over the next 12-24 months,
especially relative to the US. Still, the asset class
remains less favoured relative to equities and should
remain Underweight in 2015 and 2016.
GPIF: a $1trillion gorilla
On the same day the BoJ announced its revised QQE
plan on October 31st
, the Government Pension
Investment Fund (GPIF) came out with a plan to
ratchet up its equity exposure. As the GPIF is the
world’s biggest pension fund, managing assets worth
123tn yen ($1tn) as of end-2014 (equivalent to ¼ of
Japan’s GDP), this decision deserves as much
attention as the actions announced by the BoJ.
The proposed policy mix includes moving the target
domestic bond allocation to 35% +/- 10% from 60%
+/- 8%. This implies the fund may now target a bond
allocation as low as 25% compared with as high as
68% previously, cutting targeted bond holdings by up
to almost two-thirds.
Note that as recently as June 2013, the GPIF had
already proposed a much more modest reduction in
its holdings of JGBs, initially planning to cut its
target holding for domestic bonds to 60% +/- 8%
from 67% +/- 8%.
The newly proposed domestic equity allocation
targets 25% +/- 9%, up from 12% +/- 6%. The target
for international equities moves to 25% +/- 8% vs.
12% +/- 5% previously. This implies moving to a
combined target equity allocation that can be as high
as 67%, almost double the previous cap of 35%.

9. αβχ
Jumping in with both feet
The GPIF fund has wasted no time in implementing
the proposed changes. Chart 16 shows the annual
asset allocation of the GPIF since 2005 as well as
Q1-Q3 2014, excluding Fiscal Investment & Loan
Program (FILP) bonds (which are a special class of
government debt).
Chart 16. GPIF moving quickly towards new asset policy mix
62%
67%
61%
60%
58%
58%
52%
51%
47%
39%
35%
24%
15%
12%
14%
14%
14%
16%
18%
18%
19%
21%
25%
33%
12%
10%
13%
13%
13%
14%
17%
17%
18%
21%
25%
32%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2007
2008
2009
2010
2011
2012
2013
Q
1
14
Q
2
14
Q
3
14
Target
M
ax
Domestic bonds Domestic stocks
International stocks International bonds
Source: GPIF, Author’s calculations
The blue area represents the government bond
allocation, which had remained at around 60% for
most of the period 2005-2012. This had started to
decline in 2013, falling to 52% from 58%, consistent
with the initial plan to cut the target allocation by
7pp. This allocation stood at 47% at the time of the
most recently announced changes and has since fallen
to 39% as of December 2014 (end-Q3 according to
the Japanese fiscal year).
This means that since the most recently proposed
changes to target allocations, the GPIF has moved
two-thirds of the way towards its target, cutting its
bond exposure by 8pp between end-September and
end-December 2014, equivalent to offloading JGBs
worth 10tn yen.
The bond market was more than capable of
accommodating this selling pressure as the $40
collapse in Brent to $40/bbl pushed yields lower over
the same period and the BoJ was gobbling up JGBs at
an annual rate of 80 tn yen.
At the current pace, the GPIF will have already
reached its target 35% bond allocation by the end of
March 2015. There is further scope to move tactically
as low as 24% were market conditions to warrant
such a move, something that cannot be ruled out over
the next 12-24 months as inflation pressured build.
Within equities, the GPIF has edged towards its new
target at a slower pace than in the bond market,
moving around one-third of the way. The fund
increased its domestic equity allocation to 21% from
19% between end-September and end-December
2014. This equates to equity purchases worth around
2tn yen, equivalent to one day of trading volume for
all Topix Index constituents.
As of end-2014, the GPIF had the potential for a
further 4.8tn yen worth of equity purchases in order
to reach its target allocation of 25%. Given the fund
moved a third of the way in one quarter it would be
expected to have already completed these purchases
by mid-2015. However, moving to its maximum
allocation of 24% would imply a further 14.6tn worth
of purchases, or around 7 days of trading volume.
While some of this powder might justifiably be kept
dry in the event of a sudden collapse in the market, a
continued move away from bonds will likely lead to
an equity allocation above the target during 2016-17.
Conclusions
With the BoJ now committed to an annualised 3tn of
Japanese equity purchases and the GPIF reallocating
assets of a similar scale, there is significant positive
momentum behind risk assets in Japan in 2015. The
potential for yen weakness as a result of the BoJ’s
massive balance sheet expansion should help drive a
further rerating of equities, underpinned by continued
improvement in earnings. With inflationary pressures
likely to build, the case for owning JGBs remains low
for the next couple of years.
Wesley Fogel

10. αβχ
Wesley Fogel
Investment Strategist
Tel: +44 7860 264 902
Email: fogel@hotmail.com