Asset allocation of Defined Contribution (DC) pensions in Japan has historically been criticized for an over-reliance on principal-guaranteed products, but this is gradually improving due to the recent adoption of asset management practices. The next challenge is how to address the problem of participants who believe they are practicing diversification but are instead engaging in concentration. A survey of 36,000 DC participants revealed that among those using balanced mutual funds, 10% simultaneously held both passive and active funds, and 40% also invested in domestic stocks, a reality that reveals overlapping investments and a failure to properly diversify risk.
The problem lies in the lack of a mechanism to make individuals aware of this concentrated exposure. Out of concern that it may be construed as investment advice, employers and financial institutions do not point out to participants, “This is becoming a concentrated investment.” They only present a basic portfolio as a general educational example, but participants cannot apply it to their own specific situation. In the same survey, the top reason why workplace education was not useful was “It lacks specificity and is difficult to apply to my own situation.” This is the dilemma inherent in the current form of information provision.
There are several ways to circumvent this. While telling a participant, “Change to this product at this time,” would constitute investment advice, a suggestion purely intended to prompt awareness of concentration is highly unlikely to be classified as such. By clearly defining this line, the actions of employers and pension providers will change, and effective information dissemination will become more prevalent.
Unintentional concentrated investment can also be prevented through system design. Since many people misunderstand that holding many products constitutes diversification, limiting the choices to asset classes with clearly distinct risk and return characteristics would be a solution.
Ultimately, mandatory diversification through the default investment option is effective. In Europe and the US, they have entered an era where the quality of diversified investment is guaranteed not by individual behavior but by plan governance and regulatory measures. Japan may be in the phase of improving individuals’ decision-making abilities through enhanced education, but ultimately, we must also consider measures to overcome the inherent limitations of this approach.
(Haruka Urata, Representative, Urata Management & Finance Lab)
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