Japan public pension funds urged to replace bonds with stocks Japan's huge public pension funds have been urged to overhaul their investment strategies, replacing bonds with stocks and other risky assets to support prime minister Shinzo Abe's effort to bring an end to almost two decades of deflation. The funds" bond-heavy portfolios have long been an important prop for Japan's Y840tn ($8.4tn) government bond market, with interest rates held low despite some of the biggest budget deficits in the world. But with the Bank of Japan now buying enough Japanese Government Bonds (JGBs) to keep yields stable while inflation begins to climb, the time is ripe for public funds to put more money into higher-yielding assets, according to Takatoshi Ito, chairman of a government-appointed panel that delivered its final report on Wednesday. The BoJ's "achievable" inflation goal of 2 per cent should be used as the basis for assessing returns, said Mr Ito, a professor of public policy at the University of Tokyo. Public funds "should prepare for a transition from deflation to inflation." About Y200tn of assets will be affected by the panel's recommendations, which should see public funds including the Government Pension Investment Fund (GPIF), the world's largest pool of retirement savings, increase holdings of stocks as well as real estate trusts, infrastructure and private-equity investments. More money is also likely to spill overseas, which could keep domestic prices firm by maintaining downward pressure on the yen. "[The reforms] will be, I hope, a game-changer in the Japanese stock market and the foreign exchange market," said Mr Ito. IN Pensions Industry Since returning to power last December, Mr Abe has made higher asset prices a cornerstone of his plan to revive the world's third-largest economy after years of stagnation. So far, the sharp drop in the yen has pushed up companies" profits, causing the Nikkei 225 stock average to beat all other major markets this year. Property, too, has shown signs of its first pick-up since the Lehman crisis. But in recent months the equity rally has run out of steam, causing some to question whether institutions and individuals in Japan are ready to abandon their conservative approaches to investment. The BoJ's aggressive bond-buying had been supposed to encourage life insurers, for example, to swap JGBs for higher-yielding assets such as stocks and foreign bonds. But so far such moves have been minor. Nomura Securities, one of the most energetic cheerleaders for "Abenomics," this week cut its year-end forecast for the Nikkei by 15 per cent, to 15,250. It closed on Wednesday at 15,076, up 45 per cent since January 1. Analysts note that some of the panel's reforms could take time to implement, as they require changes to laws. One of the recommendations, for example, is for public funds to set up separate pools, or "baby funds" of actively-managed assets. Such dynamic allocation is a rarity in Japan, where portfolios have historically been fixed - say, 50 per cent in domestic bonds, 30 per cent in equity, and the balance in foreign stocks and bonds - then rebalanced periodically. Given this year's run in stock prices, public funds are already bumping up against internal limits. At the GPIF, domestic stocks probably accounted for about 16.5 per cent of a total Y122tn in assets at the end of October, according to Bank of America Merrill Lynch estimates. That is within sight of the 18 per cent limit under current rules, which set a 12 per cent allocation with a 6 percentage-point swing either way. A GPIF spokesperson said the fund would "examine the feasibility" of the specific recommendations in Wednesday's report. But Mr Ito said the selling of bonds could begin "right away," noting that the GPIF's 60 per cent allocation to JGBs could drop as low as 52 per cent without changing any rules. The BoJ could "easily" absorb the Y10tn or so of bonds the fund sold, he said, in a matter of "weeks or months." "The world changed in April," said Mr Ito, alluding to the BoJ's embrace of much greater monetary easing under its new governor, Haruhiko Kuroda. If the GPIF were to keep its portfolio the way it is, it would be a denial of the BoJ's inflation-targeting framework. They need to get ready for a new economic environment.