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By Chikafumi Hodo and Noriyuki Hirata
TOKYO, March 6 (Reuters) - Japan's $1.26-trillion public pension fund need not cling to the safety and paltry yields of government bonds, advisers to the fund said on Thursday, in another sign that it will shift more money into stocks and other risky assets.
With Japan moving out of its long spell of deflation, the Government Pension Investment Fund, the world's biggest pension fund, "does not need to adopt, from the outset, a 'domestic-bond-centric' stance," an advisory panel to the health ministry said in a draft report.
GPIF "should consider its investment purpose and investment goal from a forward-looking standpoint."
Prime Minister Shinzo Abe's government is pressing GPIF to buy more stocks and invest relatively less in bonds to generate higher returns for Japan's fast-greying population.
Given its size - bigger than the annual economic output of Mexico - GPIF is coveted by politicians and can have a big impact on financial markets if it shifts its investment flows.
Some of the "Abenomics" rally in Tokyo stocks over the past year has been driven by expectations that the fund would move toward stocks and away from bonds.
In turn, the fund's assets have grown by 19 percent since Abe came to office in December 2012 with aggressive reflationary policies that have pushed down the yen and spurred a jump in Tokyo stocks.
The panel reports to the Health Ministry, which oversees GPIF and is traditionally more concerned with the safety of the fund's assets than generating high returns.
Indeed, the actuarial panel remained cautious, suggesting only slightly higher returns and saying the fund should take the smallest possible risk to hit those targets.
But the apparent green light to invest relatively less in Japanese government bonds cheered stock investors, and the cautious return targets are not expected to stop GPIF from tilting toward riskier assets later this year.
The Nikkei stock index climbed 1.6 percent on Thursday, getting a boost from the GPIF news, traders said, although the glacial process of the fund's asset allocation still has further to run.
"Short-term stock investors use any GPIF-related headlines to take positions, so to them, its decision to move away from bond-centred investment is positive," said Norihiro Fujito, senior investment strategist at Mitsubishi UFJ Morgan Stanley Securities.
"But in reality, it takes a very, very long time to change the GPIF's allocation."
The panel recommends targeting returns 1.7 percentage points above nominal wage increases, little changed from the current target of 1.6 points, which was adopted at the previous review five years ago.
The report's assumptions imply a return target of 4.2 percent, versus 4.1 percent now.
"An increase of 10 basis points in the return target looks modest, but in general it looks as though the Health Ministry panel has taken into account the recent economic recovery and recent developments in the Abe administration's policy," said Hidenori Suezawa, chief bond strategist at SMBC Nikko Securities.
GPIF has leeway in deciding its asset allocations, but the panel's recommendations form the basis for the fund's decisions. The fund now invests 60 percent in Japanese government bonds and 12 percent in Japanese shares.
A separate Abe-appointed panel led by Takatoshi Ito, a Tokyo University professor, said in November that GPIF and other public funds should seek higher returns as the working population ages and payouts to retirees rise, by increasing investment in equities and infrastructure as an alternative to JGBs.
The Abe administration has signalled it wants GPIF to compile an allocation model as soon as June that would cut the weighting of domestic bonds and direct more into domestic stocks, a government source said.