Japanese rebalancing is underway

A sector breakdown shows that pension funds accelerated their portfolio rebalancing in H2 14, while nonbank depository institutions and nonfinancial corporations accumulated large amounts of foreign assets.

In terms of domestic equity investment, aggressive purchase by the pension fund sector in Q4 14 and 2014 as a whole was offset by net sales by the households. However, households’ domestic equity assets holdings actually increased in Q4 14, due to rising equity prices (adding JPY3.7trn just in Q4, and JPY5.3trn in 2014 as a whole); hence, households were not necessarily reducing their equity assets exposure but rather taking some profits. In contrast, overseas investors continued to purchase Japanese equities, likely providing support for the Nikkei.

In fact, the Nikkei has been rallying despite choppy price actions in the USDJPY since the beginning of 2015, allowing the foreign currency-based Nikkei finally to break above the long-held range since QQE started in April 2013. Such positive dynamics should continue to attract foreign capital inflows into Japanese equities.

The most notable shift in the flows into risky assets occurred in the pension fund sector, which became net buyers of domestic equities and foreign securities in H2 14 from a net seller until H1 14, likely as a result of forced rebalancing due to valuation changes (Figure 2). This shift was led by the Government Pension Investment Funds (GPIF), which announced their new benchmark portfolio at the end of October 2014. While their asset allocation for domestic equities and foreign securities reached the bottom of their new benchmark range, there remains further scope for such rebalancing flows to achieve their target portfolio. Their external investment flows are FX unhedged and will likely provide some support for the USDJPY, particularly from the downside. However, we expect USDJPY to remain range bound because of offsetting forces, such as already extended valuations and improving current accounts due to lower oil prices.

In terms of the pace of rebalancing away from JGBs, we do not think the GPIF will keep its current pace of selling; the ratio of JGBs in the GPIF portfolio already entered the target range of 25-45% in end-December. If it continues to sell JGB at the similar pace into Q1 15, it may be able to achieve its 35% target without further sales in FY 15