(Updates with release of report and news conference)
TOKYO, Nov 20 (Reuters) - The world's biggest pension fund is preparing its most ambitious overhaul since its creation more than a decade ago, a process that will eventually see more of Japan's $2 trillion in public funds invested in stocks and other riskier assets and relatively less parked in government bonds.
An advisory panel to the government of Prime Minister Shinzo Abe, in a highly anticipated report on Wednesday, proposed far-reaching reforms to the Government Pension Investment Fund (GPIF), encompassing fundamental change to its governance and investment strategy.
The scope of the proposals suggests Abe is serious about making public funds more independent and equipped to generate returns from Japan's enormous pool of public savings to support its rapidly ageing society, rather than simply seeking to boost the stock market.
But the complex nature of the reforms may mean that the 121 trillion yen ($1.21 trillion) GPIF - and the other funds that typically follow it - are slower to shift their investments than some investors were expecting.
The proposals fleshed out a September report that recommended GPIF shift away from very low-yielding Japanese government bonds (JGBs) and benchmark passive equity investments to a new index based on returns.
"With regards to the reference about altering the JGB-heavy portfolio, we mean that GPIF's weighting in JGBs is too high," Takatoshi Ito, the head of the panel, told a news conference.
Ito declined to provide specific targets, although he said GPIF could lower the weighting of JGBs to the floor 52 percent under its current allocation strategy, which could be done in the near term.
Meanwhile, GPIF's new portfolio should be crafted after receiving a new pension actuarial revaluation from the government in March, Ito said.
The fund reviews its medium-term strategy every five years based on these revaluations, with next year marking the review for implementation in the financial year from March 2015.
It may not wait for this process to play out. In June, after a relatively brief eight months, GPIF made the biggest changes to its asset allocations since the fund was formed in 2001. It raised the weighting of Japanese stocks in its core portfolio to 12 percent from 11 percent and cut JGBs to 60 percent from 67 percent.
As of the end of June, GPIF was 57.7 percent invested in yen bonds, 15.2 percent in Japanese equities, 9.7 percent in foreign bonds and 12.4 percent in foreign equities, with 5 percent in cash and other short-term assets.
The panel also proposed setting up "baby funds" that could take on more exposure to riskier assets in pursuit of higher returns and added a recommendation to invest in inflation-linked bonds.
The baby funds that would be outsourced separately from the core fund to allow them to take more exposure to riskier assets. These could go beyond investing in conventional assets and into alternative assets, such as private equity and infrastructure, Ito said.
The recommendations mark a major step in Abe's hopes to reform Japan's conservatively managed public funds to help pull the world's third-biggest economy out of 15 years of deflation and weak growth.
He wants the massive pools of money to have the resources and expertise to generate higher returns as the country's working population ages and payouts to retirees increase.
Similar recommendations in 2008 were ignored. But Ito said the involvement this time of the Ministry of Health, Labour and Welfare, which oversees GPIF, means the government has the will to carry out the reforms.
The panel said GPIF should consider adopting a new benchmak in passive investment of domestic equity investment, such as the new stock index - which focuses on return on equity (ROE) and corporate governance.
Hopes that GPIF could adopt the index has has already helped some of the 14 stocks that are in the JPX-Nikkei Index 400, but not in the benchmark Nikkei 225 average or the broader Topix.
Fast-growing, e-commerce giant Rakuten Inc has risen 9 percent since the ROE index was announced last week and Seria Co Ltd, operator of a 100 yen-shop chain, has jumped 13 percent, outpacing the 2.4 percent rise in the Topix over the same period.
It is unclear how much GPIF money might flow out of Topix and into the new index, but Ito said there will be no "overnight" rush to the new benchmark. He said, however, that the adoption of the index will prompt companies to improve investor returns.
Overhauling GPIF's structure, which is important to its ability to make sophisticated investments, will likely take more time. The panel called for increasing the budgets of Japan's thinly staffed public funds to hire experts and acquire the resources to improve returns.
GPIF is an independent administrative agency, which has to operate under a tight budget and has severe staff limitations compared with large private-sector financial institutions. The fund has fewer than 80 people managing its trillions of yen.
Converting it into a government-authorised corporation, like the Bank of Japan, would provide more flexibility, but such a change would require time and political debate over legislation.
"Whether our final report will be implemented depends on political will," Ito said.
The panel wants GPIF to consider diversifying into liquid asset classes, such as real estate investment trusts, when it reviews it portfolio from April. But investment in illiquid asset classes such as private equity, infrastructure and property would have to await the organisation's overhaul.
($1 = 100.0350 Japanese yen)
(Additional reporting by Yoshifumi Takemoto, Emi Emoto and Takaya Yamaguchi; Editing by William Mallard, Alex Richardson and Simon Cameron-Moore)