JAPAN’S GOVERNMENT PENSION INVESTMENT FUND (GPIF):
SHOULD IT BECOME A ‘HIGH-PERFORMANCE’ ORGANIZATION?

Prepared for Nomura Institute of Capital Markets Research, Tokyo
by
Keith Ambachtsheer
Adjunct Professor of Finance, and Director, Rotman International Centre forPension Management, Rotman School of Management, University of Toronto
andPresident, KPA Advisory Services Ltd., Toronto, Canada

August 2007

The Objectives and Design of this Study
We have been invited by the Nomura Institute of Capital Markets Research to assess theorganization structure and governance of Japan’s Government Pension Investment Fund(GPIF). The GPIF is the largest pension fund in the world, with ¥82 trillion invested in
the financial markets at the end of 2006. The Fund was reorganized in 2006 as an
Independent Administrative Agency connected to the Ministry of Health, Labour, andWelfare (MHLW). It is considered to be a key component of the public retirement
income system of Japan, which has gone through a series of recent reforms to make it
more sustainable. Thus the quality of the organization structure and governance of GPIF
is of the utmost importance to the Japanese people.
After summarizing the Study’s key findings and conclusions, Integrative Investment
Theory and the results of recent empirical studies of pension fund organization structureand governance around the world are employed to identify six critical factors indesigning an optimal organization and governance structure for investment funds such as
GPIF. We use these six factors to summarize the actual organization and governancestructure of Japan’s GPIF, and compare it with that of the Canada Pension Plan
Investment Board (CPPIB). CPPIB is the Canadian equivalent of GPIF, and is also a
relatively new organization, created in 1997. Significant structural differences withsignificant implications for the capabilities of the two funds will be noted.
Our study concludes with a critical assessment of the current organization design andgovernance structure of GPIF. There is some analysis of the pros and cons of staying with
its current ‘cost-, and risk-minimizing’ structure versus moving to a ‘high-performance’
alternative. Finally, the study poses some questions that should be addressed before any
significant changes are made.
The Principal Author of this Study
Keith Ambachtsheer is a recognized global authority in the field of the organization
design and governance of major investment funds such as GPIF and CPPIB. Over thecourse of his 38-year career in this field, he has written three books on the subject. His
most recent book, PENSION REVOLUTION: A Solution for the Pensions Crisis, wasreleased in January of this year. He has advised major investment funds in both theprivate and public sectors in North America, Europe, and the Pacific Rim on issues
ranging from governance and organization design, to funding policy, to investment
strategies and their implementation, including the Canadian government on the structureof CPPIB (see Appendix I).
Four years ago, he began work on founding the Rotman International Centre for Pension
Management (ICPM) at the University of Toronto. ICPM has become a major sponsor of
research into the organizational effectiveness of pension organizations around the world.
The Centre has 18 Research Partners, all of which are major pension organizations from
Europe, North America, and the Pacific Rim. Keith is the Founding Director of ICPM,
and was the lead researcher on a recently-concluded ICPM study titled “The State of
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An Organization and Governance Study

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Global Pension Fund Governance Today: Board Competency Is Still a Problem” (seeAppendix II).
The Nomura Institute of Capital Markets Research was helpful in providing a dossier of
useful information about GPIF. A special thanks goes to Mr. Toshio Taki of the Institutefor his prompt attention to a series of follow-up questions by the author for further
information and clarification.
Key Study Findings and Recommendations
We summarize the key study findings and recommendations as follows:•

The investment mandate, as well as the organization and governance structure
chosen for GPIF, drives it towards a ‘cost- and risk-minimizing’ culture. In
contrast, countries such as Australia, Canada, New Zealand, and Sweden havechosen mandates and structures that are driving their national reserve funds
towards ‘high-performance’ cultures.

•

Key elements of ‘high-performance’ investment funds are organizational
independence, professional board-of-directors oversight, expert internal
investment and control capabilities, and performance-based compensation
schemes.

•

While the national reserve funds with ‘high-performance’ cultures do not yet havelong performance histories, early results suggest that they are meeting or
exceeding their expectations. For example, in its just-released Annual Report,
CPPIB disclosed that it generated an additional 2.5% of return ($2.4 billion) in2006 above the return of its Reference Portfolio through their own active public
and private market activities. In contrast, GPIF results suggest that, consistent
with its current mandate and structure, actual returns are very close to benchmark
returns.

•

We believe that redirecting GPIF to become a ‘high-performance’ investment
fund would offer Japan three significant potential benefits: (1) higher returns on
its public pension reserves, (2) establishment of a ‘centre of pension fundmanagement excellence’ in Tokyo, and (3) a tangible contribution towards
establishing a more productive form of global capitalism.

•

A decision to redirect GPIF towards becoming a ‘high-performance’ fund requiresthat Japan first address questions related to its national risk tolerance, to creating atruly independent GPIF legal structure, to defining the required GPIF board of
director characteristics, selection process, and accountability structure, and towhether sufficient national trust and confidence exists for this GPIF
transformation to be successfully completed.

We now proceed to provide the bases for these findings and recommendations.
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An Organization and Governance Study

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A Theoretical Framework for the Study
In his Nobel Prize-winning formulation of investment theory in 1952, Harry Markowitz
proposed that we think of investor value-creation (or welfare-, or ‘utility’-creation) as
finding the optimal portfolio combination of expected return and risk, where risk relates
both to the riskiness of individual investments and also their covariance with otherinvestments, and where risk tolerance is captured as a willingness to acquire additional
units of expected return at the cost of additional units of expected risk at the total
portfolio level.
Markowitz’ original formulation of investment theory assumed all investors make theirown risk/reward assessments of individual securities, and build their own portfolios.
Today, most financial wealth is managed not by individuals, but by institutions. Thisinstitutionalization of wealth management requires a reformulation of investment theory
that integrates institutional agency and governance issues with those of risk, return, andthe willingness to trade off one for the other. In a 2005 Financial Analysts Journal,
Ambachtsheer proposed Integrative Investment Theory (IIT) as follows:
Stakeholder Value = f{A, G, IB, R, FE/IMPL, S}
This formulation of investment theory proposes that the creation of maximum
stakeholder value in institutional fund management contexts requires the effective,
integrative application of six value-driving factors: (1) Agency Issues, (2) Governance
Structure, (3) Investment Beliefs, (4) Risk Management, (5) Financial Engineering/
Implementation, and (6) Scale.
1. Agency Issues: every investment fund has principals (i.e., the asset owners) andagents (i.e., people who act on behalf of the owners). In the GPIF context, forexample, the ultimate principals are current and future Japanese citizens. The
agent chain begins with the elected representatives of the Japanese National Diet,and then moves on to the Minister of Health, Labour, and Welfare, to MHLW
officials, to the GPIF Investment Advisory Committee, to the GPIF President andinternal GPIF management, and finally, to a large collection of external agents
providing a variety of investment and related services to GPIF. Principal-agent
issues arise in this kind of structure because principals and agents have potentiallyconflicting goals. More specifically, investment funds like GPIF (and others aswell) create the potential for all of the agents in the chain to choose to consider
their own interests alongside of, or in conflict with those of the fund ‘owners’. IIT
recognizes this potential and requires that agency issues are identified andaddressed as part of the stakeholder value-creation process. Research findings
suggest agency costs in the investment field can be highly material, reaching 24% per annum of assets under management in some situations [1].
2. Governance Structure: even if all agency issues were correctly identified andaddressed, institutional fund management could still be ineffective. There is alarge body of research that has helped define effective organizational governance
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An Organization and Governance Study

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and management principles and practices. We ourselves have been engaged in thisresearch process, specifically focusing on the investment fund context. This
research suggests that to be truly successful, an investment fund must have four
elements operating in an integrative manner: (1) a clear mission/mandate, (2) askilled, motivated oversight body accountable for ensuring that the overall
mission/mandate is achieved, (3) a skilled, motivated executive/professional teamaccountable for the development and implementation of plans designed to achieveorganization goals consistent with the mission/mandate, and (4) the necessary
human, information, and financial resources required to achieve the task. The
systematic application of these four elements measurably improves organization
performance, including that of investment funds. For example, studies in which
we have been involved found that well-governed pension funds outperformed
poorly-governed ones by an average 1-2% per annum on a risk-adjusted basis.
These studies also confirm that there continue to be significant barriers to creatingstrong governance mechanisms in the global pension fund sector [2].
3. Investment Beliefs: an investment fund’s investment policies should be guided by
an explicit, defensible set of investment beliefs. An important element of any
investment beliefs set is whether future investment returns are identically,
independently distributed (‘iid’) with known parameters (i.e., known expected
returns, return volatilities, and correlations). This belief (or its absence) has
important implications for how fund investment policies and investment mandates
should be articulated and implemented. For example, in an ‘iid’ world, investment
policies can remain unchanged for long periods of time. In a non-‘iid’ world,
investment policies need to be dynamically adjusted to changing circumstances.
Over the course of the 1980s and 1990s, a wide consensus developed in theinstitutional funds management world that we did indeed live in an ‘iid’ world
characterized by a large positive (i.e., +5%) expected Equity Risk Premium (ERP)over the long term, and a manageable level of shorter term ERP volatility (i.e., in
the 10%-15% per annum range). Actual events over the 2000-2003 period, andnew emerging research results now challenge this broad ‘iid’ view of capital
markets behavior [3]. Thought-leading investment funds around the world favoreda decidedly non-‘iid’ view well before the 2000-2003 period of financial stress.
Practically, this meant reclassifying the fundamental investment strategies into
three categories: risk-minimizing (RM), short horizon-risky (SHR), and longhorizon-risky (LHR). RM strategies cover payment obligations in as low cost, lowrisk manner as possible. SHR strategies involve generating excess returns throughadversarial trading in securities, derivatives, currencies, commodities within a
pre-determined amount of risk exposure (e.g., long-short absolute return investingis a SHR strategy). LHR strategies involve acquiring uncertain future cash-flows
at reasonable prices, and enhancing the size and quality of these cash-flows postacquisition (e.g., passive indexing, active public equity engagement, private
equity, real estate, or infrastructure investment strategies). With the exception ofpassive indexing, all of these strategies involve active participation in investment
processes. A key management task in a non-‘iid’ world is to assess the return

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An Organization and Governance Study

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prospects for these three types of strategies (and their sub-components), and to
optimally combine fund exposures to the strategies over time.
4. Risk Definition, Measurement, and Management: investment risk has many faces.
Proper measurement and management requires that risk is defined in a relevant,operationally useful manner. In the context of a fractional reserve pension fundsuch as GPIF, risk for the principals (i.e., Japanese citizens) can manifest itself asa requirement for higher contributions into Japanese public pension arrangements
than anticipated, lower pension payments than anticipated, or some combinationof the two. Thus the challenge for the Japanese Government is to devise a
dynamic protocol that changes contribution rates and plan benefits in anunderstandable, even-handed manner as circumstances change. The GPIF
challenge is to convert these political goals into a risk policy for the assets under
its management that is consistent and explainable to the general public. Such arisk policy should be consistent with the investment beliefs of GPIF [4]. Of course
the financial risks of the GPIF principals are not the only type of risk that theorganization must control. It must also manage the operational risks associatedwith operating a large investment fund. GPIF must also manage its reputationalrisk. If Japanese citizens lose confidence in GPIF as an institution looking after
their financial interests, the future of GPIF would become very uncertain.
5. Financial Engineering/Implementation Strategies: strategies based on themathematics and instruments of modern finance (e.g., derivatives) are essential tothe efficient implementation of risk-based investment policies and related
investment mandates. For example, sophisticated risk models are required toaggregate individual risk exposures into an estimate of total fund risk exposure.
Further, that total fund risk exposure needs to be decomposed into its major
sources (e.g., net equity, yield curve, credit, or foreign exchange exposures). If
risk exposures need to be modified, it is often most cost-effectively accomplishedthrough derivatives. However, the effective adoption of these implementation
strategies is not costless. Their use requires combinations of highly trained andskilled people, high-powered mathematics, and significant, ongoing expenditures
on information and control technologies. The modern investment organization
sees these expenditures not as costs, but as investments with potentially very large
pay-backs.
6. Scale: investment management is generally a highly scalable activity. For
example, a ¥10 trillion index fund can be managed for virtually the same cost as a
¥1 trillion index fund. Thus, given its very large size, GPIF should be able tomanage many of its functions at very low unit costs. At the same time, scaleoffers the opportunity to acquire the necessary resources to become a ‘highperformance’ organization. However, very large size can also be a disadvantage
in investment areas where there are capacity limitations. Experience shows thatthe cost of these capacity limitations can be minimized by thinking and managing
funds such as GPIF on a global rather than local basis.

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An Organization and Governance Study

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In the next section of the Study, we use the six value-drivers framework to compare GPIF
and CPPIB along each of the six dimensions. We believe that understanding the material
differences in organization structures of GPIF and CPPIB, and how those differences
impact on value-creation potential, is important for reasons that will become clear in thematrix displayed on pages 8-13.
GPIF vs. CPPIB: Significant Differences
The matrix makes clear that the differences between GPIF and CPPIB along the six
value-driver dimensions explained above are fundamental rather than marginal. The
differences start with the respective legal positioning of the two organizations. CPPIB is atruly independent organization, while GPIF, with its costs controlled by government
actions, is not. The two oversight processes are also fundamentally different. GPIF
oversight is provided through government agencies, especially MHLW. The primary
CPPIB oversight mechanism is a professional Board of Directors, specially selected andappointed for that purpose. GPIF oversight is diffused and distant. CPPIB oversight isfocused and direct. These two oversight processes will elicit quite different behavioral
and motivational responses from inside executives and professionals.
Beyond agency and governance, the differences between the two organizations extend
into how they form, revise, and integrate investment beliefs into their investment policies.
The GPIF processes appear static, grounded in a conventional, backward-looking ‘iid’
view of the world. The CPPIB processes are dynamic, responsive to changing
circumstances. The differences extend further in how the two organizations define,measure, and manage risk. Starting with its mandate, GPIF seems to have a very riskaverse attitude towards financial risk-taking. The CPPIB approach is to convert ameasured amount of approved and controlled risk-taking into additional return on assets.
Also, CPPIB explicitly manages possible reputational risk through a pro-active
stakeholder outreach program.
Finally, the differences extend into how the two organizations implement their strategies
over time, and how they use their large scale. GPIF appears to focus almost exclusively
on maintaining a low profile, and minimizing costs. In contrast the focus of CPPIB is toturn its scale into a comparative advantage in order to build a visible, world-class ‘highperformance’ investment organization. Thus the organization will consciously ‘invest’ in
expensive people and technology if the expected payoff from making those investments
is high enough.
Personal observation and research with which we have been involved suggest the
combined impact of these factors should translate into an average 2%-3% percentage
point margin of additional return per annum after expenses in favor of CPPIB. Indeed, the
CPPIB just reported a 2006 return of 12.9% on assets versus a 10.4% return on its
Reference Portfolio, implying its active management strategies generated a net excess
return of 2.5% in 2006. In contrast, the GPIF reports returns by asset class, with actual
returns very closely matching benchmark returns in most cases.

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An Organization and Governance Study

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Agency
Issues

NICMRI – Japan’s GPIF
An Organization and Governance StudyGPIF- GPIF was established as an
Independent Administrative
Agency in 2006 to invest thefinancial reserves of Japanesepublic pension schemes.

CPPIB- CPPIB was established as anindependent Crown
Corporation in 1997 to invest
the financial reserves of theCanada Pension Plan.

Observations- As an IAA, it is assumed to- As a Crown Corporation,- If GPIF cannot control its own

operate independently from
the MHLW.

CPPIB operates independently
from government.

- However, as an IAA, GPIF is- Through a Ministerial

subject government-wide
restraints on its operating
costs, including compensation(but external management feesare exempt from theserestraints).

oversight committee, theCanadian federal andprovincial governments holdthe CPPIB’s Board of
Directors accountable for
ensuring that CPPIB candevelop and implement plans(including compensation)required to achieve its
mission.

budget to create success, thenit is not really an independent
organization, with likely
adverse performance
consequences. For example, if
internal costs are controlled,
but external fees are not, there
will be a bias towards
outsourcing, even though that
may not be the best option.

- There is clearly a difference inthe degree of independence
enjoyed by GPIF and CPPIB.
CPPIB controls its own
budget, and GPIF does not.

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Governance Structure

GPIF
CPPIB
- GPIF has no Board of- CPPIB is governed by a
Directors to provide oversight. professional board of
directors. Board selection is- An Investment Advisory
based on an arms’-lengthCommittee (IAC)
process that focuses on therecommends asset mix andprofessionalism and the‘other important matters’ towillingness of candidates to
the GPIF President.
make a contribution to ‘thepublic good’.
- The 11-member IAC isappointed by the MHLW, and - The Board is responsible forhas a strong academic rather
selecting and evaluating thethan business orientation.
CEO of CPPIB.
- The GPIF President is also

appointed by MHLW, andhis/her performance isevaluated by the MHLW.
- The President is responsible

for the development andimplementation of plans(strategic and operating) toachieve the GPIF mission.

NICMRI – Japan’s GPIF
An Organization and Governance Study- The CEO is responsible forthe development andimplementation (with Board
approval) of plans (strategicand operating) to achieve the
CPPIB mission.

Observations- The CPPIB governancestructure and process follows
directly from the application
modern ‘best practice’
governance principles andresearch findings.
- The GPIF’s lack of a Board of

Directors to provide strong,
professional oversight is aserious shortcoming in thecurrent GPIF governancestructure. This gap inoversight cannot be filled byeither the Investment
Advisory Committee (it has
no authority) or by MHLW
officials (they are too far
removed). The likely result is
to adhere closely to the rules
set out for the organization,with no attempt made to earn
additional returns over theestablished benchmarks.

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Investment
Beliefs

GPIF- The MHLW provides GPIF
with a long term nominal
return target (currently 3.2%).
- GPIF (with advice from IAC)

develops a Basic Portfolio it
believes will achieve thereturn target (currently Dom.
Bonds-67%, For. Bonds-9%,
Dom. Equities-11%, For.
Equities-9%, Others 5%).

- CPPIB research has identified

Observations- The Japanese and CanadianGovernments have both set
target returns for their national
pension reserve funds. The
Canadian target (4.2% real) is
set considerably higher thanthe Japanese target (3.2%
nominal).

appears to be that security
returns are identically,
independently distributed(‘iid’), and hence expectations
can be based on historicaloutcomes.

a passive Reference Portfoliothat it believes, at current
prices, could earn the target
4.2% without undue risk
(Dom. Bonds-35% of which
10% is inflation-linked, Dom.
Equities-25%, For. Equities40%). This Reference
Portfolio will be re-estimatedevery few years, based onchanging expectations.

- Another key underlying GPIF

- CPPIB believes it can add- The current structure of GPIF

assumption seems to be that
undertaking active risk does
not have a worthwhile payoff.

significant value to theReference Portfolio return
through a variety of active
strategies in the public andprivate markets. A long
investment horizon andsignificant scale are important
contributors to this belief.

naturally leads to taking amore conventional approach
to investment thinking. Thisimplies it will never be a ‘firstmover’ in discovering andimplementing new investment
ideas to achieve or surpass its
target return, unless it changes
its structure.

- A key underlying assumption

NICMRI – Japan’s GPIF
An Organization and Governance Study

CPPIB- The Chief Actuary of Canada
has calculated that CPP
reserves have to earn a net
real return of 4.2% for thecurrent contribution rate to besustainable into the future.

- CPPIB has hired investment

professionals who are on theleading edge of investment
thinking and its implications.
This gives CPPIB an
important ‘first mover’
advantage in discovering andimplementing new investment
ideas to achieve or surpass its
target return.

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Risk
Management

GPIF- The derivation of the Basic
Portfolio seems to almost
fully define how muchinvestment risk the GPIF
should undertake.
- As already noted above, there

CPPIB- The derivation of theReference Portfolio is an
important part of risk
management at CPPIB. As anext step, the CPPIB Board of
Directors has, with the adviceof CPPIB professionals,
assigned an active risk budget
within the overall fundinvestment process must
function.

Observations- The GPIF and CPPIB

approaches to risk
management both start with
the identification of abenchmark portfolio that
captures the governments’return ambitions withminimum risk.

is little room for taking active
risk in the current mandate
and structure. While the- However, in the case of GPIF,
active/passive split is
the Basic Portfolio isofficially 20/80, we surmise
effectively provided by athat the truly ‘active’ positions - Operating within this risk
group of outsiders (i.e., thein the 20% of GPIF being
budget requires close coIAC). In the case of CPPIB,
actively managed are in fact
operation between all CPPIB
the Reference Portfolio isunits, including thesmall.
derived by CPPIB itself, andinvestment units, risk
approved by its Board of- As a result, there is no
management, and financeDirectors.
perceived need at GPIF for
operations. All investment
sophisticated risk
units (e.g., public markets,- Finally, CPPIB is assigned an
management tools or real-time private equity, real estate,
additional active risk budget
information systems.
infrastructure, high-yield debt,
by its Board of Directors inetc.) can ‘bid’ for a portion oforder for the organization to
the total fund active risk
generate additional return.
budget.
- There is no such process at
GPIF.

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An Organization and Governance Study

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Financial Engineering
Implementation

GPIF- Once the Basic Portfolio isdecided, strategy
implementation should be a
relatively simple process at
GPIF.

CPPIB
- Strategy implementation is an
ongoing, complex dynamic
process at CPPIB, involving
both internal and external
investment management
resources.

- However, we note that GPIF

currently employs 10 trustbanks and 30 investment
advisors to manage the 90%of assets managed externally.
It is not clear to us why somany investment agents are
required to implement what
are largely passive investment
mandates.

- As already noted, the risk

management and finance
operations units play criticalroles. Incentive compensation
also plays a critical role, with
its philosophy of paying forexcess returns, properly
measured.
- CPPIB also has a program to

manage its reputational risk. It
is in constant contact withsuch key stakeholder groups
as the Canadian media, thinktanks, politicians, and thegeneral public.

NICMRI – Japan’s GPIF
An Organization and Governance Study

Observations- Implementation strategies are
executed very differently at
GPIF and CPPIB.
- In the GPIF case, it is therelatively simple matter of
allocating assets according to
the dictates of the Basic
Portfolio.
- In the CPPIB case, a muchhigher level of complexity
needs to be managed, as avariety of internal andexternal active strategies in
the public and private markets
needs to be monitored andintegrated. Another importantfactor is that incentive
compensation is based (atleast partially) on generatingexcess return. Thus there is ahigh level of importanceattached to measuring results
accurately.

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ScaleGPIF- GPIF managed ¥82T at thestart of 2007, an amount thatis expected to increasesignificantly for some time to
come.

CPPIB
- CPPIB managed C$117B at
the start of 2007, with assets
expected to triple in the next
15 years.

- GPIF uses scale in a defensive- It considers its large scale a- Up to this point, GPIF appears

to have used its large scale
only to reduce unit costs, with
only 60 employees on the
payroll at the end of 2006.
Government fiscal restraint is
expected to shrink thisnumber even further.
Meanwhile, external advisor
fees are only 0.038% ofassets.

NICMRI – Japan’s GPIF
An Organization and Governance Study

Observations- GPIF and CPPIB see theimplications of scale very
differently.

comparative advantage by
permitting the organization tocompete for top talent, andinternalize an increasing
proportion of its investment
and support activities. Overthe next year, it plans to add
100 people to its current
number of 260, and open
offices in London and Hong
Kong.

sense to reduce unit costs.
- CPPIB uses scale in an

offensive sense (e.g., acquires
additional resources toglobalize its operations) togain a comparative advantage
in order to generate additional
net return in excess of theReference Portfolio return.

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Choices for JapanThe matrix makes it clear that Japan has chosen a ‘cost- and risk-minimizing’ strategy for
managing the financial reserves of its public pension schemes. As a result, with adequate
controls, the GPIF should be able to produce the Basic Portfolio nominal return target of
3.2% at very low implementation costs.
This study contrasts Japan’s ‘cost- and risk-minimizing’ strategy with the ‘highperformance’ strategies being adopted by some other national reserve funds, such as
those of Australia, Canada, New Zealand, and Sweden. The specific example chosen inthis study for a detailed comparative analysis was Canada’s CPPIB, an organization withwhich the author is very familiar (see Appendix I). Why should Japan at least consider
joining the countries that have chosen the ‘high-performance’ pension reserve fundroute? Three major benefits of doing so would be:
1. A significant increase in the expected return on Japan’s public pension reserves.
A return increase of 2% per annum would increase Japan’s public pension
reserves by a highly material additional ¥1.6 trillion each year. This would help
ease the already-recognized financing challenges of Japan’s public pension
schemes. Increasing the target return by this magnitude should be accompanied byan assessment of the risk implications, and how they could be mitigated.
2. The creation of an internationally-recognized ‘centre of excellence’ in pension
fund management in Tokyo. Japan has built a justified global ‘excellence’
reputation in the design and manufacture of consumer products. Why not in
pension fund management too? Associated with such a choice would be increased
research in Japan in (a) capital markets and financial institutional structure, and(b) in the risk measurement and management of reserve funds such as GPIF. The
choice would also lead to the development of a group of investment professionals
who can compete with the best in the world in such global developing areas asrelationship investing, private equity investing, infrastructure investing, high-yield
investing, and emerging markets investing [5].
3. A boost to the evolution of a more productive form of capitalism: there is a
growing consensus that a global capitalist structure which includes
knowledgeable, properly-motivated institutional owners would reduce agencyrelated frictions in the capitalist system. Independent ‘high performance’ national
reserve funds are ideally suited to play such a role, and indeed are already doing
so in the countries noted above [6]. A redefined and restructured GPIF would
accelerate this process, for the benefit of all.
Any one of these three benefits would be a significant contributor to Japan’s future
welfare. Together they could be transformative to how Japan addresses pensions andinvestment issues in the 21st century.

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An Organization and Governance Study

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Questions for Deciding
In deciding whether to adopt a ‘high-performance’ organization model for GPIF, here are
five key questions Japan will need to address:
1. Are the Japanese people psychologically prepared to move GPIF to a higher
risk/reward ‘high performance’ environment?
2. What legal structure would provide the best opportunity for GPIF to achieve theautonomy required to successfully implement the ‘high-performance’ model?
3. What would have to be the characteristics of the board of directors that would
oversee a ‘high-performance’ GPIF? [7] And to which Japanese body would thisboard be accountable for achieving GPIF’s mission?
4. What would be the best process for selecting the members of such a board?
5. Would the Japanese people trust such a board to select a CEO to whom the board
would delegate responsibility for devising and implementing plans for GPIF toattain its ‘high-performance’ vision?
Five profound questions. We encourage the Japanese people to consider them carefully.

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An Organization and Governance Study

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ENDNOTES[1] A recent Rotman ICPM study by Bauer et al. titled “The Performance of US Pension
Funds: New Insights into the Agency Costs Debate” compared the performances ofsimilar investment mandates executed by pension funds and retail mutual funds. They
found the pension portfolios outperformed the retail mutual fund counterparts by anaverage 2-3% per annum, net of expenses. They attributed much of the performancedifferences to differences in agent motivation, with the interests of pension fundmanagers being more closely aligned with those of their ‘clients’ than is the case with themutual fund managers, who also care about the profitability of their own businesses. In
the case of GPIF, the scales may be tipped too far in the other direction, with costminimization being given too much emphasis at the expense of ‘client’ wealthmaximization.
[2] A recent Rotman ICPM study by Ambachtsheer et al. titled “The State of Global
Pension Fund Governance Today: Board Competency Still a Problem” surveys the statusof pension fund governance around the world. It also provides estimates of theperformance differential between well- and poorly-governed pension funds in the 1-2%
per annum range. The study is appended to this document.
[3] See Part IV of our new book PENSION REVOLUTION titled ‘Investment Beliefs”. It
documents our own non-‘iid’ views, as well as those of critical thinkers such as authorPeter Bernstein, John Campbell of Harvard University, Andrew Lo of MIT, and Woody
Brock of Strategic Economics.
[4] See Part V of PENSION REVOLUTION titled “Risk in Pension Plans” for further
elaboration of these ideas. The critical challenge is to covert ‘soft’ perceptions of risk
tolerance by diverse groups of pension scheme participants into a ‘hard’ risk budget forthe pension fund.
[5] Observers have suggested that Toronto has already become a global ‘centre of
excellence in pension fund management’. It is the home of a number of major pension
funds with global reach, including the CPP Investment Board. It is the home of theRotman International Centre for Pension Management at the University of Toronto. It isalso the home of CEM Benchmarking Inc., which monitors the cost-effectiveness ofmany of the globe’s leading pension delivery organizations.
[6] See Part VII of PENSION REVOLUTION titled “Pensions, Politics, and theInvestment Industry” for an elaboration of these ideas. See also THE NEW CAPITALISTS
by Davis et al. on the implications of the institutionalization of the ownership of
productive capital. They foresee an emerging ‘civil economy’, where successful
enterprises are increasingly those that demonstrate productive commercial dynamism inthe context of clear accountability to its institutional owners.

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[7] See Part III of PENSION REVOLUTION titled “Pension Fund Governance” forpossible answers to this question, especially Chapter 15 (“Should (Could) You Manage
Your Fund Like Harvard or Ontario Teachers?”) and Chapter 18 (“High-Performance
Cultures: Impossible Dream for Pension Funds?”).

READING REFERENCES
Ambachtsheer, Keith, “Moving to a ‘Fiduciary’ CPP Investment Policy: Two Possible
Paths”, June 1996 (www.kpa-advisory.com).
Ambachtsheer, Keith, “Beyond Portfolio Theory: The Next Frontier” 2005, Financial
Analysts Journal, Jan-Feb.
Ambachtsheer, Keith, PENSION REVOLUTION: A Solution to the Pensions Crisis, 2007,
Wiley, NY.
Ambachtsheer, Keith, Ronald Capelle, Hubert Lum, “The State of Global Pension Fund
Governance Today: Board Competency Still a Problem”, 2007, Rotman ICPM Working
Paper, (http://www.rotman.utoronto.ca/icpm/).
Bauer, Rob, Rik Frehen, Hubert Lum, Roger Otten, “The Performance of US Pension
Funds: New Insights into the Agency Costs Debate”, 2007, Rotman ICPM Working
Paper, (http://www.rotman.utoronto.ca/ca/icpm/).
CPP Investment Board, ON COURSE: 2007 Annual Report, (http://www.cppib.ca/).
Davis, Stephen, Jon Lukomnik, David Pitt-Watson, THE NEW CAPITALISTS: How
Citizen Investors are Reshaping the Corporate Agenda, 2006, Harvard Business School
Press, Boston, MA.
Nomura Institute for Capital Markets Research, “Basic Information on the GPIF”, 2007.

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