Strategic Shifts in Japan's Pension Funds: Navigating Active Fund Underperformance and Currency Risk

Japan’s pension funds are undergoing a seismic shift in asset allocation strategies as active fund underperformance, market volatility, and currency risk reshape the investment landscape. Over the 2023–2025 period, active equity funds in Japan have consistently lagged behind passive benchmarks. For instance, the Hennessy Japan Fund returned -0.89% in March 2025, underperforming its Russell/Nomura Total Market™ Index benchmark by 1.83 percentage points [1]. Similarly, the Government Pension Investment Fund (GPIF) reported a ¥71.6 billion underperformance in its active equity portfolio during FY2024, despite efforts to diversify and adopt a “scientific framework” for manager selection [4]. These trends reflect broader global challenges for active managers, where only 33% of active funds outperformed passive peers in the 12 months through June 2025 [1].

The root causes of this underperformance are multifaceted. First, Japan’s equity market has experienced sharp volatility, exemplified by a 12% single-day drop in August 2024 driven by global macroeconomic risks and yen appreciation [2]. Second, currency risk has compounded challenges for active strategies. The yen’s depreciation in 2025, fueled by delayed U.S. rate cuts and trade tensions, has created a mixed environment for exporters and importers, complicating stock-picking [3]. Third, the rise of passive strategies—historically lower-cost and tax-efficient—has intensified pressure on active managers to justify their value [2].

In response, Japanese pension funds are recalibrating their portfolios. The GPIF, Japan’s largest pension fund, has maintained its 50/50 stock-bond allocation but has increased active foreign equity exposure to 17.8% of its portfolio as of March 2025 [2]. This shift is part of a broader diversification strategy, with the fund splitting its equity portfolio into four regional buckets (North America, Japan, developed markets excluding Japan, and developed markets excluding North America) to reduce concentration risk [2]. Additionally, GPIF has reduced its FX hedge ratio from 70% to 45% to better manage currency exposure amid policy uncertainty [1].

Other pension funds are adopting even more radical approaches. The Federation of National Public Service Personnel Mutual Aid Associations (KKR) slashed its active fund exposure from 13% to 8.9% by exiting 10 underperforming funds [1]. Meanwhile, the Daiwa House Industry Pension Fund has allocated 57% of its assets to alternative investments like private equity and hedge funds, signaling a departure from traditional bonds [3]. These moves underscore a growing preference for diversified, non-correlated returns in a low-yield environment.

The strategic rebalancing of Japan’s pension funds reflects a pragmatic response to a challenging market environment. While active management remains viable in fixed-income and alternative asset classes [1], equity strategies are increasingly being replaced by passive or beta-balanced approaches. For investors, this shift highlights the importance of fee structures, diversification, and dynamic hedging in volatile markets. As GPIF and its peers continue to refine their strategies, the lessons from Japan’s pension funds may offer a blueprint for global investors navigating an era of uncertainty.

**Source:[1] Market Commentary and Fund Performance [https://www.hennessyfunds.com/insights/portfolio-update-japan-fund-january-2025][2] GPIF pins active equity overhaul on 'scientific' manager selection [https://www.top1000funds.com/2025/07/gpif-pins-active-equity-overhaul-on-scientific-manager-selection/][3] Japan Pension Shuns Bonds With 57% of Fund in Alternative Assets [https://www.bloomberg.com/news/articles/2025-06-27/japan-pension-shuns-bonds-with-57-of-fund-in-alternative-assets][4] GPIF's Global Equity Allocations: A Blueprint for Diversification in a Volatile World [https://www.ainvest.com/news/gpif-global-equity-allocations-blueprint-diversification-volatile-world-2507/]