The terrain for mutual funds in Japan has been rough. Many foreign firms rushed in following deregulation in the mid-1990s expecting a pot of gold. The market is miniscule, yet Japan has the world's second largest savings pool and its investors desperately need better returns to enjoy a dignified retirement. But disappointment over the structure of the new defined contribution law, sagging stock markets and a perceived risk aversion among Japanese investors has prompted many firms to scale back their retail business or close shop altogether.
Bill Wilder, president at Fidelity Investments in Tokyo, speaks with FinanceAsia about why Fidelity continues to like doing business in Japan.
FinanceAsia: What are the highlights in the industry's history?
Bill Wilder: The first deregulation took place in 1987 but it wasn't a real business. Investment trust companies could only source new accounts of meagre size and the fees were too low. We did however become one of the first three managers to win a mandate from the Pension Fund Association, in 1990. In 1991, foreigners were allowed to apply for an investment trust license. There were four firms that got it, Mercury, Credit Suisse, Jardine Fleming and Invesco. Schroders also got one a few months later. But to do discretionary asset management with a trust business, you had to set up a whole separate company, which was too expensive, and there were a lot of restrictions, so we decided to wait.
Then in 1995 came the Big Bang. Suddenly the arduous hurdles for the investment trust business simply went away. In 1997 so did the 5/3/3/2 Rule, which stipulated how much pension funds could invest in various asset classes. So we applied for a license, and we got our first employee pension fund client in 1996. Today we have 134 institutional clients.
Are there still deregulation issues?
The next layer down of deregulation remains a work in progress, but it is a process of many technical things, such as average block trade pricing. But the real restrictions were lifted in 1995. You can do pretty much what you want.
Asset management is of increasing importance here. If you make the internal case for mutual funds in Japan, suddenly all these negatives become positive, because the market is infantile in many ways. For example, pension funds are corporations, but the Investment Advisory Association doesn't require marking to market. Personal assets remain under the mattress, or even in gold. It's an ageing society but the mutual funds industry doesn't exist. Why? One reason is that unit trusts aren't managed in perpetuity. Distributors prefer closed-end funds that they can liquidate, and then sell a new one to investors. Fidelity's was possibly the first open-ended fund in Japan.
Clients are ill-served in other ways. Fund managers at life insurance companies and trust banks have been shackled by the 5/3/3/2 Rule as well as by relationships with their keiretsu. They don't have the freedom to sell the stock if they have a relationship with that company. And thanks to jinji-ido - the regular rotation of people in traditional companies - they haven't developed the necessary portfolio management expertise.
Is that changing?
Increasingly, asset management is becoming key for financial institutions. Nomura, for example, has been upgrading asset management. Financial institutions' asset management affiliates are being developed into good firms. All the distributors want to leverage their asset management business. They want to build up their asset management affiliates or get assets under management with a consistent fee base.
Churning hasn't been 100% the fault of brokers. Brokers attract a certain kind of investor, maybe one that isn't well educated. Even at Fidelity's own broker, where we never recommend people sell their funds, we often get high redemption rates.
And other customers are risk-averse.
The mutual fund industry here is about $330 billion, and about a third of that is in equities. Well, our flagship Magellen Fund in the US has almost as much assets as the Japanese equity-structured funds market. Here you have $10 trillion of personal assets but no one knows how to invest. Everyone says the Japanese are risk-averse. I think it's because no one has sat down with them to explain the basics of risk and investing. We also need a sustained recovery in the stock market. And I think over time, defined contribution and the growth of variable annuities will help.
Is the recent collapse of the money management fund (MMF) market going to set back that progress?
People did not get severely burnt by MMFs. Corporations were the ones with the most concern. Most of the money that left MMFs was corporate, and a lot of asset management companies here have decided not to let corporations buy MMFs anymore. MMFs are not appropriate for institutional investors, because their asset sizes are too big. It makes MMFs hard to manage.
If you look at variable annuities, and we have products now in VA wrappers, the sales have been impressive. This is an ideal product for banks to sell.
But DC has been a disappointment.
We've started seeing inflows, either directly or from our banks and brokers, plus one fund in the post office. Fidelity pushes Japanese equities, and in the past six weeks, the market has gone up 20-25%. The initial success of DC investments has surprised some people. The Japanese market last year was a disaster, but if you had taken a three-year investment view, you would have made money. The problem is no one is thinking past what's hot now. People would do all right if they applied dollar-cost averaging, especially since September of last year.
What does the industry need to succeed?
We need a return to a normal market. I don't know when it will happen but at some point the economy will recover. Then 12 to 18 months later corporate earnings will rise, and some time before that, the stock market will rise in anticipation of earnings. If the bull market of 1999 returned, and stayed, it would be wonderful.
If the economy doesn't recover in the next two years, I don't know. There's no visibility. Our business is premised on Japanese equities. We have 13 Japanese equities funds. One of them is the third-largest mutual fund in Japan. We have two funds in the top-five.
We have a good institutional product line. This year we want to broaden retail and add fixed income. For institutions we want to add non-traditional assets. We don't do anything heavy in derivatives or take currency bets, but otherwise, without meaning to sound arrogant, we can do anything.
Are you introducing a funds supermarket here, like you have in the US?
Our broker sells third-party funds but there is no supermarket platform. Brokers and banks already have a lot of funds on their shelf. Maybe a supermarket would make sense if independent financial advisors come into their own.
You mentioned earlier that you distribute one fund via the post office. To what extent is this the big gorilla that hinders competition?
The post office can only distribute mutual funds in individuals' DC programmes. It is a big gorilla, but no one knows how effective it is. You're not going to see all 25,000 branches selling mutual funds. Right now only a small number do, and it will eventually expand to only 600 or 700 branches. The other branches are too small, unless somehow DC becomes automated. We also don't know how privatization will pan out - will it be split into one company handling mail and another in financial services? Kampo is also supposed to be privatized, and it could be a potential distributor as an insurance company. But what we do know is that if you're not on the post office's DC platform now, it will become more difficult to get on it in the future.
Does the retreat of rival foreign fund managers help you?
ABN Amro is withdrawing, Gartmore is exiting unit trust business - these things are all a concern to me. It makes all the foreign companies look fickle. And US firms bring something here. Merrill Lynch tried to change things too fast but their goal was a good one. The market hasn't been built yet. I'm not throwing my hands in the air and yelling, Banzai! Another one's bitten the dust!
But I think most of these retrenchments have been due to internal factors or the way the business model was established, not so much because you can't run a mutual fund business in Japan.