PensionsAsia invited several leading foreign fund managers to discuss whether foreignersÆ market share of managing Japanese assets has hit a high-water mark. The panelists met on the morning of 8 August at the Imperial Hotel, Tokyo.
Jame DiBiasio, managing editor, PensionsAsia
Yumiko Akabane, assistant vice-president., INVESCO Asset Management (Japan)
Takanori Hiramoto, president, Baring Asset Management Japan
Tetsu Hirano, vice chairman, AXA Investment Managers Tokyo
Clifford Shaw, chairman, Merrill Lynch Mercury Asset Management Japan
Christopher Wells, partner, White & Case, and chairperson, financial services committee,
American Chamber of Commerce in Japan
Lucy Abbott, second secretary, United States Embassy (observer)
PA: Can Japanese asset managers compete better as they consolidate under Big Bang financial deregulation?
Takanori Hiramoto: There are many things that are happening today that are quite new. The subsidiaries of the two largest insurance companies, Sumitomo Life and Asahi Life, have both hired a CEO from outside the firm and have been able to create organisations that are different than what we had regarded traditionally as simple subsidiaries of financial companies. We also observe the system of wages, or how companies pay gradually being changed û as we know, Japanese companies tend to rely on the lifetime employment system, with wages related to seniority rather than performance.
I have interviewed quite a lot of people over the past few months, and professional people at Japanese companies are being paid competitive wages û far more competitive than what we have seen in the past, but along the lines of the global level. So thereÆs no question about the behaviour of the Japanese companies changing, and if anything theyÆre becoming more competitive.
Clifford Shaw: Fund management before wasnÆt thought of as a specialist job. Companies were still working in the job-rotation mode; people would do fund management for two years and then go off and do something else. WeÆd get trainees from Japanese financial institutions. WeÆd look after them for a few months and then theyÆd go to work for a firm in New York or Boston for a little while. Then theyÆd come back and get a job in an asset management department in Japan. Suddenly weÆd get a phone call from one of these very bright people whoÆd tell us theyÆre now going off to sell insurance in Fukuoka. As long as that sort of thing was going on it was very difficult to develop the expertise. But that has definitely changed.
And thereÆs much less resistance to people moving to a new firm. That used to be viewed as treachery and is much more accepted today. YouÆve seen people like Dai-Ichi and IBJ merging their forces on the fund management side. And the gaps in the domestic market where this is a matter of survival, where they have to be able to manage Japanese bonds and equities, weÆre seeing these being filled. We view these companies as very serious competitors. Overseas there tend to be more gaps, so Japanese companies have sought alliances with overseas companies.
PA: What is the state of the health of these alliances, particularly joint ventures between foreign asset managers and Japanese firms? How many will be around in five years?
Shaw: This isnÆt just in fund management, but you often find in joint ventures between Japanese and foreign companies, the two parties come in with different sets of ideas about how itÆs going to work in practice. I canÆt think of any long-term, stable examples of joint ventures.
Christopher Wells: In financial services, I canÆt think of many either. From a lawyerÆs point of view, when you design these JVs, you want to be sure everybody knows what theyÆre getting into, not just the economics but the social adjustments that are needed by foreign managers. The foreign asset manager brings technology, the Japanese asset manager brings business and relationships. Sometimes the Japanese asset managerÆs strategy is to learn all the techniques and terminate the joint venture, and the foreignerÆs strategy is to learn all the customers and gain their confidence, and break off on their own. It doesnÆt make for the best joint venture, because everybody expects that the otherÆs motivation is just what it is.
One issue is how do you define the right scope of business area where there can be cooperation. Another is how do you design the right exit strategy so both parties can go their own way without hurting their institutionsÆ names. One of the more durable examples would be AIMIC, a joint venture between AIG and Mitsubishi Trust û it continues to roll out new products. But over a 10-year period the mortality rate could be as high as 80%. Domestic joint ventures are often just done for press. The anecdotal evidence is those joint ventures existed more in the press release than in practice.
PA: How would foreigners fare during a sustained equities bull run in Japan?
Tetsu Hirano: More advanced institutional clients û now they donÆt care who manages the fund. They will be looking at performance over a longer period of time, and will continue to allocate to foreign asset managers. Of course the major part of a fund will go to Japanese asset managers, but if foreign asset managers have reasonable expertise, if they can provide performance and good research, they will have good opportunities. Anywhere in the world will be the same û domestic assets will be 80-85% of an allocation. Therefore itÆs natural, whether itÆs in Japanese equities or Japanese fixed-income, for a Japanese fund manager to take market share away from us.
PA: What about the yen/dollar exchange rate, any impact on your fortunes?
Hirano: In 1985 the yen stood at 80 to the dollar, and fell to 148 in 1998, so any offshore investment had a big return. The amounts going into US dollar money market funds were increasing, it created demand for foreign investment. The 1995-98 golden years of foreign asset managers are gone, but thereÆs still reasonable demand out there. Japanese clients are still looking for a second set of products, and they will continue to invest abroad.
Wells: My experience is the that the holy grail of asset managers and fund sponsors in Japan trying to find a new product is a yen-denominated fund with a decent return. Returns on domestic projects are very difficult to achieve right now. ItÆs almost essential that any fund you create has some offshore investment, hopefully yen-denominated so itÆs yen-hedged. By far the largest market is for yen-denominated and covered product. Very few retail and even institutional investors want foreign exchange risk.
Shaw: If you want to be here in 10 or 15 years' time, you have to compete in both domestic equity and domestic fixed-income products. The good news is in both the mutual fund and institutional market, performance is becoming more important. In the past, mandates were awarded on non-performance grounds. The money often stayed at companies within the same group. Mandates were given to fund managers who agreed to become long-term stable shareholders. But nowadays thereÆs a realization on the part of the corporation that the sums of money in pension funds are very significant and the difference between good managers and bad managers can be several percentage points of return a year.
Similarly in the domestic market, people like Morningstar and Standard & PoorÆs, who attach ratings to mutual funds, are gaining attention. Domestic securities companies have pushed the products of their own subsidiaries, and the share of foreign fund managers has fallen back a bit. I think thatÆs a temporary trend.
Yumiko Akabane: For retail, you have to maintain a good relationship with your distribution channels. And good performance remains the key. If investment companies have the performance, more and more distribution channels will want to sell your product. ThatÆs the way it works. On the institutional and pension side, the idea is the same, but you also need to expand or at least maintain your assets with good record keeping. You also need to provide good information to consultants, so theyÆll introduce you to their clients. Increasingly business isnÆt directly with clients, but through consultants.
PA: Since 1997-98 one foreign fund manager after another enjoyed soaring inflows of assets, only to lose the business to another. How real is foreignersÆ growth in market share?
Wells: Japanese investors are not as fickle as statistics make them appear. A lot of that activity is driven by securities companies in the distribution channel, and the relative immaturity of the typical Japanese IT investor in the foreign model of long-term investment. The Japanese investor tends to be a speculator or somebody who simply listens to their distributor. TheyÆre not the target investor for the American or European type of model of a fund. Everyone wishes it were different and I donÆt think those fund managers necessarily knew they were getting into the hot money. And when they were doing really well, they were told the good times are over and itÆs time for the hot money to buy other hot places. It was a disappointment for some fund managers but a good learning experience.
Hiramoto: The people who use a broker are different than those who buy a mutual fund through a bank or an insurance company. The management of these brokerage companies continue to encourage this. I donÆt see any sign of change. New managers continue to do exactly the same thing, and some executives will openly tell you theyÆre in it for the commission, not to gather assets.
Wells: As inept as bank windows can be for selling funds, in the long-term thatÆs where your investments are best placed because theyÆre likely to stick. Some investment-banking style foreign fund managers established reward systems to encourage a run-up of funds and I think those systems should be re-evaluated.
PA: What kind of distribution arms do you look to build?
Hirano: The average holding period of a mutual fund for Japanese retail investors is less than 18 months. Total net assets of investment trusts in 1987 was around Ñ58 trillion. Today itÆs about the same û it hasnÆt grown. Some distributors have very big volume û they push a product and when performance is good they take profits and switch somewhere else. This is the chicken-and-egg problem: when we have good performance we kill ourselves. Therefore what we have to do is diversify the distribution channel, and develop the sustainable growth avenues û banks, regional and smaller brokers. We are very close to our insurance affiliate, which can provide another channel.
If I want distributors to sell our products for at least a three-year duration û we have to quote this in advance with distributors. ThatÆs my approach, to find long-lasting distribution channels that wonÆt turn over our product. This is quite tough, but the total amount of investment in investment trusts hasnÆt grown. Why? We have to sustain the assets.
Wells: YouÆre seeing more JVs designed around insurance sales forces. Firms are realizing that targeted investors are not the ones brokers can bring you. This has good long-term potential.
Shaw: There is still a tendency to look at investment in securities as speculative. You can buy shares Monday through Friday, and on the weekend you go to the racetrack. Brokerages have done nothing to dissuade this. The 1970s and 1980s could have been a very rewarding time for Japanese investors, but in practice they didnÆt do that well.
Since commercial banks have entered the market in December, 1998, they have obtained a market share of around 8.5% and theyÆve exhibited much lower turnover than brokers. Merrill Lynch hired from the failed Yamaichi Securities to create its own broker sales force, to try to change the paradigm from churn-and-burn to asset gathering, but this is a new message. We must remember that even in the United States it took people a while to realize it was in their best interest to focus on keeping the clients for a long time.
PA: Foreigners got away with charging a premium in the past, especially for non-yen products û is this sustainable?
Hiramoto: In the pension business, we have been able to raise prices. We raised our own fee table in late 1998 in line with fee tables we use in the US and UK markets. To the extent that pension sponsors use consultants, which has risen substantially, the clients tend to be less sensitive to the absolute fee level. WeÆve been able to charge higher fees than we used to because the clients are buying a process, a philosophy and style, not an investment return. We can continue to make a stand and argue for a higher fee structure than what Japanese companies charge.
We have a cost structure that is higher, we have a global investment process, not only in Japan but worldwide. So naturally what we offer costs more. I think it will work and it is important that shareholder pressure on Japanese companies will inevitably make its presence felt, and they will eventually demand a higher return so Japanese financial services companies will be forced to charge a fair price, and not go into a discounting spree.
Shaw: People are being forced to pay much more realistic salaries for fund managers these days. It is going to be difficult for people to dump in terms of fees. If someone has managed your money badly it doesnÆt matter if they donÆt charge fees at all.
Wells: ItÆs very early times for institutional corporate pension management. ThereÆs now disclosure required on contingent liabilities and the impact of that is only beginning to be felt. CompaniesÆ management is going to be forced to look for better performance to manage down its pension liabilities coming due in 10 or 20 years. These things donÆt happen overnight and we will only begin to see this over the next two or three years. That will mean more dialogue between corporate pension managers. WeÆll see a lot more expertise developed internally at the controllerÆs function to manage that liability. YouÆll see more auctions, incentive schemes. Have any of the people at this table seen more performance-based compensation arrangements in this market?
Shaw: ThereÆs very little around, actually. The objection is if youÆre not careful about the formula, youÆre actually incentivizing your managers to take huge risks.
PA: What about in-house management û is that a threat?
Hirano: Hitachi already has their own asset management company.
Shaw: At the moment they manage just Japanese equities and theyÆre outsourcing the rest.
Wells: ItÆs hard to see how it makes sense û the idea that you make money managing the assets is less compelling than having 25 institutions with the best people competing to get your mandate. Those examples such as Hitachi or Toyota arenÆt the wave of the future û itÆs the institutional market. When I mention this to foreign clients their eyes move to the ceiling and they start to yawn. But I believe the opportunities for foreign asset managers in institutional pensions are far greater than on the retail side. The least prepared for all the changes taking place in the market are the institutions, and the retail market needs so much more education.
PA: Will defined contribution become the high-growth market or are foreign asset managers going to find defined benefits a better business?
Shaw: A lot of companies mistakenly thought that by switching from defined benefits to DC they would in a leap and a bound be free of their liabilities and their problems would be at an end. As reality sank in and it also became clear tax authorities would oppose over-generous annual ceilings, there has been a certain amount of disillusionment. ThereÆs a very real danger that corporate pressure for the introduction of DC is waning and the legislation wonÆt get through. Even if it does get through it will be a difficult birth. Even in the States in the early days participants went into bond funds and money market funds, despite signs of the beginning of a bull market in the early 1980s. In Japan, those percentages in principal guaranteed funds will be very high. Nobody makes money managing those. From a money managerÆs point of view this market may be interesting in five to 10 yearÆs time.
Akabane: We have a big DC business in the United States and weÆre trying to build up a Tokyo business now. There is a future here but for now the business itself is uncertain. It is difficult to get human resources û what kind of people have the ability or knowledge about this business? TheyÆre hard to find in Japan û weÆre still looking.
Hirano: Local consortia are building the DC record-keeping platforms but the service fee will not be cheap û someone must pay a record-keeping fee. Investment managers just provide asset management products, which are simple: Japanese money market funds, for example. For foreign asset managers, we need opportunities to provide global products where we have a competitive edge. WhereÆs your competitive edge in a local money market fund? Our life insurance company sales force can give us an opportunity to sell different kinds of products, but the third-party DC plan business will be tough for any foreign investment managers if they involve platform development. It will mean seven, eight years of losing money. How much money do you want to lose?
Hiramoto: We are interested in providing content and not infrastructure: investment products on an unbundled basis to whoever makes the decision to use those funds, whether itÆs a fund administrator, a consultant or a plan sponsor. Pricing will be a big issue, and other things not related to investment, such as things that are convenient with the sponsor or administrator or back-office people. WeÆre very excited at the long-term prospects, but the near-term prospects are limited to earn a profit.
Wells: Seven to 10 years is aggressive in terms of some of the business plans we have seen. Any newcomer has to be prepared for a very long haul. On the other hand, the potential assets are tremendous. The problem is the amount of deferrable income is so modest, it isnÆt helpful.
Shaw: Defined benefit pension plan mandate decisions tend to be made on performance-related criteria. The DC business, on the other hand, is more about systems and administration. In that regard, foreign firms lose their advantage. There is a positive, however, and that is the DC process means many companies will have to arrange education campaigns for their employees. This is, in the long run, good for the fund management industry. I think in 10 to 15 years from now weÆll look back at this and say, æYes, we have benefited from the introduction of DC.Æ In the meantime, however, traditional business relationships in Japan will play a greater role in administration and education.
Hirano: The education requirements and the limited distribution channels are a problem for us. WeÆre looking at the UK and the role of independent financial planning there. In the US, brokers sell IT funds through financial planners. In Japan, insurance companies are supposed to provide customers with long-term advice, but financial advisers arenÆt at the level of the US or UK.
Wells: Now they just sell a product, theyÆre not really independent advisors.
Shaw: There are a few independent advisors but itÆs not a big industry.
Wells: ThereÆs no licensing of CFAs, and youÆre unlikely to find any at securities distributors. But this could change. I understand at the Nissan Group, they have a stated goal that every sales lady earn a CFA.
Hiramoto: Staff is the most important issue for us. We work at a combination of making an impression of the value of our company: making it recognizable, a brand, a stable organization offering first-class products. ItÆs quite important to be known as competing at the top echelon of the industry. And we have to pay a competitive wage.
PA: So how do you attract the best professionals?
Akabane: Japanese people are demanding greater salaries. But foreign companies often have a reputation as hiring and firing very quickly. That makes them risky to work for. ThereÆs more choice today for people wanting to get into the investment business. Ten years ago there were maybe 20 investment trust companies in Japan; today there are 70. So there are more options, but still very few qualified, experienced people. What theyÆre often looking for is stability, a company that can provide them with a career. High turnover means thereÆs a problem.
Hirano: We ask people we interview, æWhat do you want to achieve?Æ If they have a goal and reasonable expectations about compensation, they are attracted by our ability to provide a clear challenge and the means to get there. It generates passion.
Shaw: WeÆve not yet seen a rush away from investment management into dotcoms. Banks and insurance companies used to be at the top, when asset managers were viewed as subsidiaries. Now itÆs a fashionable career.
Wells: There is a distinct group of self-selected people working for foreign companies. Some Japanese people could never work for an international corporation, they just canÆt fit in, theyÆre depressed in an international environment. Younger people, however, see it as a valuable experience û but the support network and incentives must be carefully tailored to them.
Shaw: Mergers are creating a new generation of people whose career paths have been disrupted. WeÆre seeing a steady flow of applicants.
PA: LetÆs sum up, then. Can foreigners continue to grow their aggregate market share of managing Japanese assets, or are the glory days over?
Shaw: The market is ever more competitive. Foreign players who are less committed wonÆt achieve scale, theyÆll see a lot of red ink. They will have to reconsider operating in this market. Those companies with a significant investment and commitment can still compete. There will be room for a number of foreign players, in retail or institutional markets. Each of those can sustain five or six industry leaders.
Akabane: Foreign investment advisory companies still have the best expertise. Japanese firms are catching up, but they simply lack some of our advantages. I think we can continue to increase our market share.
Hiramoto: ItÆs difficult to name another sector in Japan that is as open and deregulated as investment management. ItÆs competitive, yes, but the field is wide open. You have to have performance, the right products and commitment, but I canÆt think of any other sector IÆd want to work in. ThereÆs unlimited growth. Collectively for foreigners, I donÆt know, but we each have great potential.
Hirano: I saw a 1998 survey that expects the investment trust market to grow from Ñ59 trillion today to Ñ178 trillion in 2010, including defined contribution. If everything works out well û in terms of the right tax benefits and a proper education effort û the industry will grow to three times its size in 10 years. Whether youÆre foreign or Japanese, investors can benefit, so the market will grow. We can worry about results later. For now we have to meet investorsÆ needs in order to survive.