Japan's Sumitomo Mitsui Trust dials up risk with alternative investments push

A recent alternative investing deal between Sumitomo Mitsui Trust Bank Ltd. and Apollo Global Management Inc. has underscored the pressure on Japanese financial institutions to seek higher returns from riskier assets amid market volatility.

The Sumitomo Mitsui Trust Holdings Inc. unit plans to invest $1.5 billion in alternative funds managed by the U.S.-based asset manager. The Japanese company could also later codevelop similar products for its own retail and pension fund customers.

The planned investment is part of the Japanese entity's strategy to expand into the private assets market. Private assets under Sumitomo Mitsui Trust’s management totaled ¥4.1 trillion as of March 22. The company aims to grow that to ¥24 trillion by March 2031, it said Aug. 18.

The alternative investment plan has its risks, especially with increasing uncertainty over the U.S. economic outlook, a key market for Apollo, said Takahide Kiuchi, executive economist at Nomura Research Institute.

Some Japanese financial institutions, such as Government Pension Investment Fund of Japan, or GPIF, and Mitsubishi UFJ Financial Group Inc. have sought to improve returns by increasing investments in alternative assets such as private equity, real estate and infrastructure. The diversification attempt has come as returns on domestic investments in Japan, particularly bonds, have been hit by chronically low interest rates.

The Japanese government also said in March 2021 it plans to woo more foreign asset managers to help broaden the range of investment products, including alternative assets, via tax breaks, visa rule changes and English-language services.

Timing

The partnership with a non-Japanese investment manager — fairly uncommon in Japan — has highlighted a growing need by companies to access external expertise to invest in alternatives.

The deal, however, may get off to a bumpy start as Japanese investors, who are generally more conservative than those in the U.S. and EU, are turning more risk averse given the rising recessionary pressures at home and abroad, analysts said.

Private equity assets — a traditional pillar of alternative investments — are also taking a hit from volatile markets. The sluggish stock market in the first half of the year damped stock prices of unlisted companies as well, while higher interest rates raised fundraising costs for investors seeking to allocate cash to those companies, analysts said.

Private equity companies' global fundraising for the second quarter plunged 50.5% from a year earlier to $119 billion and may slow further in the coming quarters, while exit values also plummeted 51.7% to $150.7 billion during the same period, according to data from Preqin, an alternative assets tracking company.

In July, global private equity and venture capital entries slid to the lowest monthly totals of the year, hampered by soaring inflation and rising interest rates. Deal value worldwide fell 63% to $43.05 billion from $116.47 billion a year earlier, according to S&P Global Market Intelligence data.

"The new macroeconomic environment of sustained high inflation and higher interest rates threatens to undermine some of the comparative advantages that private equity has had over public equity markets," said Cameron Joyce, deputy vice president for research insights at Preqin.

Apollo's private equity assets also shrank to $83 billion in the April-to-June quarter, and represented 16% of total assets, down from 18% in the previous year, according to the company's earnings statement.

A spokesperson at Sumitomo Mitsui Trust declined to comment on when and how the bank will allocate the $1.5 billion investment in alternatives.

Conservative investors

Higher U.S. interest rates have also swelled valuation losses for Japanese banks on their investments in overseas bonds such as U.S. Treasurys.

Large Japanese institutional investors have little choice but to look at higher-yielding, but riskier, assets such as alternatives.

GPIF, for instance, increased its investment into alternative assets to ￥2.158 trillion in March 2022 from ￥100.6 billion five years ago as part of a diversification strategy. Still, the investment represents just 1.0% of its total assets, indicating that the manager of the world's biggest pool of retirement savings relies heavily on traditional investments in bonds or stocks. GPIF can invest up to 5% of overall assets in alternatives.

It is also indicative of how conservative Japanese institutional and individual investors remain.

If Sumitomo Mitsui Trust eventually opts to develop an alternatives fund appropriate for retail investors, it will face a massive challenge in convincing individual investors that alternatives are a good proposition.

Japanese households own about ￥2 quadrillion in financial assets; about half of that is in savings instruments.

Japan's individual investors are markedly more conservative compared with their counterparts in the U.S. and EU: 54.2% of household assets in Japan were held as cash or bank deposits, 28.4% was allocated to insurance and pension funds, 9.6% to securities, 3.4% to investment trusts and 1.4% to bonds in the financial year ended March 2020, the Bank of Japan said.

In contrast, the allocation to securities was 32.5% in the U.S. and 17.2% in the EU, while cash and bank deposits accounted for 13.7% and 34.9% of household assets, respectively.

As of Aug. 30, US$1 was equivalent to ¥138.73.