On the Possibility of GPIF to engage in Impact Investing

Within Japan's impact investment community, there is growing discussion about the possibility of the Government Pension Investment Fund (GPIF) starting impact investing. This discussion was sparked by an announcement from the Ministry of Health, Labour and Welfare (MHLW) on November 25, 2024, stating that GPIF could engage in "investments that integrate impact" (*1). (Note added on April 2: In the Fifth Medium-Term Plan announced on March 31, 2025 (*2), GPIF itself officially announced its intention to pursue this initiative. ) Here, "impact" refers to the social and environmental effects brought about by investee companies, such as reducing greenhouse gas emissions.

By law, GPIF is required to operate “exclusively for the benefit of policyholders.” This legal framework prohibits “extraneous considerations,” meaning GPIF cannot invest pension funds for purposes unrelated to the benefits of policyholders, such as achieving specific policy objectives unrelated to pensions.

The scope of what constitutes "extraneous considerations" has been subject to interpretation, including whether "impact" falls into this category. However, the recent announcement clarified that "integrating impact from the perspective of improving investment returns" does not fall under extraneous considerations.

Notably, the announcement specifies that GPIF is permitted to engage in "investments that integrate impact" but does not explicitly use the term “impact investing.” What does this distinction imply?

Impact investing includes two types: those aiming for returns above market averages and those that do not. Since GPIF is obligated to prioritize improving investment returns, it can only consider the former category of impact investments targeting returns above market averages. Thus, the MHLW's announcement appears to delineate this specific subset of impact investments as “investments that integrate impact,” making it clear what GPIF can target. This interpretation aligns closely with the concept of “instrumental IFSI” (Investments for Sustainability and Impact) outlined by the Principles for Responsible Investment (PRI) in its framework on legal structures for impact-focused investments (*3).

The announcement also contrasts “investments that integrate impact” with the existing “investments that integrate ESG (Environmental, Social, and Governance) factors.” ESG investing by GPIF primarily refers to passive equity investments based on ESG indices. By contrast, “investments that integrate impact” is likely envisioned as active equity investments integrating impact considerations.

Integrating impact in investments is a relatively new domain, and no industry-standard methodologies exist yet. In this pioneering field, it is vital for stakeholders to identify practical challenges and address them from various perspectives. Fortunately, Japan is developing a foundation for public-private collaboration on social impact and impact investing. GPIF's commitment to “investments that integrate impact” is expected to accelerate this movement. At Cadira Capital Management, we aim to contribute to this momentum by developing innovative investment methodologies and engaging in dialogue with relevant stakeholders.

Lastly, we outline below some practical challenges from the perspective of asset managers when integrating impact considerations into listed equity investments:

1. Increased Operational Burden

Impact investing requires additional research on impact factors alongside conventional investment activities. This added workload and associated costs could pressure fund returns, asset manager profitability, or both.

To address this issue, asset managers must establish efficient operational processes, such as integrating investment decisions with impact evaluations and leveraging IT systems.

2. Limited Investment Universe

Focusing on specific impact targets narrows the investment universe. According to the efficient market hypothesis, narrowing the investment universe deviates from optimal risk-return characteristics. Excessive focus on specific impact targets could lower the likelihood of outperforming the market.

To achieve returns above market averages, it is necessary to set broader impact targets. Additionally, for publicly traded companies, balancing discipline and flexibility regarding the proportion of revenue tied to impact is crucial since many companies operate across multiple business areas.

3. Complexity of Investment Decisions

Adding impact considerations when evaluating investments transforms the decision-making structure into a three-dimensional model (risk, return, and impact). This complexity can create challenging situations, such as whether to maintain investments in companies with high impact ratings but overvalued stock prices due to rapid increases.

Simplifying the framework by integrating impact considerations into existing investment process is essential for consistent decision-making. One approach could be incorporating impact considerations into corporate value calculation, thereby reducing the three-dimensional analysis to two dimensions.

References:
*1 Ministry of Health, Labour and Welfare, Pension Bureau: “Activities to Fulfill Stewardship Responsibilities and Investments Considering ESG and Impact.”
https://www.mhlw.go.jp/content/12501000/001337872.pdf

*2 The Fifth Medium-term Objectives

https://www.gpif.go.jp/info/other/5thmidtermplan.html

*3 PRI: “Legal Framework for Impact-Focused Investments.”
https://www.unpri.org/download?ac=15845