Investment behaviour in historically conservative Japan is changing, with investors looking for new products, giving rise to opportunities for global asset managers. But how can asset managers capitalize on this situation?
A shift is underway in the Japanese asset management industry and in the Japanese investor community. The historically conservative market is changing sentiment, opening a new opportunity for global asset managers. So how can managers looking to expand into Japan seize this chance?
Several factors are driving this change, including the requirement for higher yielding products to combat the ultra-low interest rate environment and account for population longevity. Consolidation within pensions following the dissolution of companies’ employee pension funds is also shaking up the industry.
Japan’s Financial Services Agency (FSA) has started tightly monitoring a practice known as “churning.” Churning has historically inhibited the sale of financial products to retail investors. Now, regulators are emphasising managers’ fiduciary duty and enforcing risk/reward profiles for product suitability. The Corporate Governance Code and the Stewardship Code also focus on independent decision making and are changing the way managers do business.
Understanding the Opportunity
There are three key segments to understand the Japanese market: retail, pension funds, and corporate accounts, which are mainly financial institutions. Currently, Japanese asset managers are limited in their capabilities to offer non-Japanese and non-traditional products, sending much of the market overseas. Those segments could be more successful if they diversify their portfolios to non-traditional securities, including funds and foreign securities.
Changing Retail Segment
Household financial assets totalled ¥1,655 trillion as of March 2017 with roughly 80% held in bank deposits and insurance products. However, as the post-war baby boomers retire, younger generations are accumulating deposits and investments and unlike previous generations who favoured conservative investment strategies, they may look to select investments from a wider range of options.
The well-known longevity of the Japanese population has created the need for long duration products with a sustainable yield. Historically, investors regarded Japanese dividend distribution products as a stable source of income.
The popularity of the individual-type defined contribution (DC) pension plan (iDeCo) has been growing since its introduction in 2011. The typical retirement age in the corporate sector is 60 years old, and sometimes earlier, whilst state pension pay-outs start at 65. The decline of defined benefit plans and increase in DC has also been a trend and iDeCo can potentially fill the cash flow gap before 65, and top up payments from DC plans.
NISA, the tax-exempt savings account, and Junior NISA for minors, may also be another trigger for the gradual shift of retail investors from bank savings to investments via a fund.
With assets under management totalling ¥315 trillion as of March 2017, the pension segment in Japan has also been undergoing change. Many small company employee pension funds have dissolved and assets transferred to the Government Pension Investment Fund, Japan (GPIF), the largest public pension fund in the world with ¥162 trillion in total assets.
GPIF recently established an investment committee to reviewed asset allocations. They are shifting towards non-Japanese instruments and will likely substantially increase its allocation to these instruments. They also openly discuss their asset allocation policies and performance-based compensation structure with third-party managers. Mutual Aid Associations, a public pension fund with AUM of ¥54 trillion, has also outsourced most of their asset management to external managers.
Whilst some corporate pension funds are developing their strategies for asset allocation, many continue to depend on trust banks for their fund selection and monitoring.
New Asset Allocations for Financial Institutions
Across all Japanese banks and insurance companies, there is a combined total of ¥760 trillion invested in securities. Historically, institutional investors have invested a majority of their portfolio into JGBs. However, the negative interest rate policy is inspiring more institutional investors to move into other investment categories, often selecting foreign fixed income, high yield loans and debt, and foreign equities.
Insurers and banks have been under pressure to overcome asset liability mismatches and the guaranteed rates of return set before the lost decades. Within the accounting and regulatory constraints such as capital adequacy regulations, many in this sector prefer to set up private funds to manoeuvre their investment policies and comply with necessary conditions.
With increasing allocations to non-traditional asset classes, banks and insurers have also sharpened their risk management. Yet the actual securities selected in the riskier asset classes cannot be executed in-house, or even in-country due to the lack of asset managers who can source such expertise. Therefore, these functions often rely on specialist managers overseas.
Understanding Unique Requirements of Japanese Investors
Consequently, in this context of a shifting landscape, there are opportunities for overseas asset managers. But what do they need to consider to be successful? One of the first questions asset managers often ask is whether a physical presence is essential in Japan. In fact, foreign asset managers can tap into the Japanese market in several ways.
They can, for example, establish a local presence, obtaining a status of Type II Financial Instruments Business and/or of Discretionary investment, or partner with a local asset manager, using an Article 63 Exemption for private placement. How to interpret relevant articles of the law and restrictions is not always black and white and managers should pay special attention to ensure they are conducting activities legitimately. It is often a lengthy process to acquire a Japanese FSA license, although the FSA is trying to make the process more transparent. Partnering with a professional firm and a service provider can help to mitigate these challenges.
Even after setting up a business in Japan, overseas entrants need to remember it is a market that is very strict in terms of accuracy, and one where there is no tolerance for NAV and administration error. As operational accuracy and timeliness are paramount in Japan, managers should consider their experience of handling such operational processes globally.
In addition to the asset diversification requirements in all three investment segments, the Tokyo Metropolitan Government is working to assist foreign asset managers entering the Japanese market by facilitating better support infrastructure. Another important consideration in the Japanese market, especially in the retail segment, is fiduciary duty, a current focus from regulators and the local government, who both hope to make financial markets more attractive for individuals to invest in, and balance the high levels of household assets held in cash or deposits.
Asset managers should not underestimate the importance of brand recognition. A strong brand is essential for driving growth in the market. However, even without a long track record or strong brand, Japanese investors prefer user friendly operational support, accuracy, speed, and customisation.
This publication is provided by Brown Brothers Harriman & Co. and its subsidiaries (“BBH”) to recipients, who are classified as Professional Clients or Eligible Counterparties if in the European Economic Area (“EEA”), solely for informational purposes. This does not constitute legal, tax or investment advice and is not intended as an offer to sell or a solicitation to buy securities or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code or for promotion, marketing or recommendation to third parties. This information has been obtained from sources believed to be reliable that are available upon request. This material does not comprise an offer of services. Any opinions expressed are subject to change without notice. Unauthorized use or distribution without the prior written permission of BBH is prohibited. This publication is approved for distribution in member states of the EEA by Brown Brothers Harriman Investor Services Limited, authorized and regulated by the Financial Conduct Authority. BBH is a service mark of Brown Brothers Harriman & Co., registered in the United States and other countries. © Brown Brothers Harriman & Co. 2018. All rights reserved. 6/2018 IS-04087-2018-06-20