No yen funds

The scenario was simple: A huge pool of maturing Japanese savings accounts would make its way into the coffers of asset managers, driving up the Nikkei and reviving the economy. So what happened?

Ten years ago Keiko Koide, a 54-year-old Tokyo housewife, deposited ¥8 million in a Postal Savings Bank account. Just a year after the Nikkei bubble burst, Koide, like millions of her fellow citizens, was looking for safety and security, and she was quite content with the 8 percent annual return paid on the account. She would be happy with half that return today, but she knows it cannot be found in any Japanese postal account, and the alternatives she confronts are uninspiring indeed: Accept a minuscule return, or take on considerable risk. Either way, forget about safety at 8 percent a year.

These days yields on Japanese savings instruments barely exist. If she rolls over her savings for another ten years, Koide could pocket a microscopic 0.2 percent annual rate from the Postal Savings Bank, the national depository institution run out of Japan’s 24,000 post offices. A three-year, fixed-rate bank deposit would net her just 0.17 percent.

If she dares to put her principal at risk, Koide could buy an equity-based toshin, the nearest Japanese equivalent to a U.S.-style mutual fund. But average annual returns for the domestic equity versions of these funds have hardly exceeded 2 percent during the past five years. That doesn,t make her heart beat faster. Besides, Koide felt discouraged when she tried to research toshin: “One big bank just shoved a pile of leaflets at me when I asked for information,” she complains.

She’s not at all sure that she should invest in the stock market. At the moment, Koide owns shares in three blue-chip companies, two of which have fallen more than 70 percent since she bought them on the advice of a family friend in the late 1980s. Despite a big rally last year, the Nikkei was down 58 percent through the end of August from its December 1989 peak.

Koide has done very well with a foreign exchange account at Citibank that allows her to switch from yen- to dollar-based short-term time deposits. But she’s not comfortable increasing her exposure to foreign markets. “I live in Japan, and I have to find a way to make my savings work for me in yen,” she says.

Koide is hardly alone. Some ¥106 trillion ($100 billion) of ten-year deposits , nearly a third of the Postal Savings Bank’s massive ¥350 trillion total deposits , matures this year and next, according to the Ministry of Posts and Telecommunications, which oversees the bank. The tidal wave of money that needs to be rolled over reflects Japan’s investing environment circa 1990. Ten years ago Japanese investors were bailing out of a miserable stock market and were attracted to the relatively high yields available on the ten-year accounts, known as teigaku yokin. Money rolled in.

When those savings started to seek a new home late last year, many asset managers thought nirvana was at hand. The most optimistic scenario went something like this: A substantial portion of the savings accounts from people like Koide would go to the toshin or directly into the equity market, setting off a powerful rally in the Nikkei, jolting the moribund Japanese economy back to life and eventually sparking the restructuring of giant Japanese businesses that were traditionally leery of shareholder concerns. Japanese and foreign money management firms, already freed to compete by financial deregulation enacted over the past decade, would expand massively to handle the investment of the huge savings pool. Japan would quickly replicate the fund management success stories already seen in the U.S. and in Western European countries like France, Germany and Italy.

Not so fast.

The Postal Savings Bank is renewing about three quarters of its deposits. Naoto Misawa, deputy director of the sales promotion division at the MPT’s Postal Savings Bureau, reports that some 70 percent of the retained funds have gone right back into teigaku yokin deposits that carry a ten-year fixed rate, but can be redeemed after an initial six-month lockup period. The rest went mainly into more liquid deposits. There’s not likely to be any big change in the Postal Savings Bank’s renewal rate during the last quarter of 2000, when an estimated ¥20 trillion of ten-year deposits comes up for renewal.

Meanwhile, the rush to equities has been, at best, restrained. Japanese savers like Koide know that stock prices can go down , fast and far , as well as up. A decade of poor performance and disappointing service from brokerages and asset managers has been sobering indeed. And in Japan, unlike the U.S. and parts of Western Europe, risk-taking or running against the crowd is still seen as somewhat aberrant behavior. The Japanese may one day embrace an equity culture, but they,re not there yet.

If money managers are to succeed, observers say, they must first alter their product offerings and marketing approach. Over the long term, brokerages and fund managers may yet make a great deal of money. But first, they must change their tune.

Certainly, they have an incentive to do so. At ¥1,350 trillion, Japan’s pool of private financial assets is the second largest in the world. About 55 percent of these assets reside in bank deposits and cash, and an additional 28 percent are in insurance and pensions (see chart, page 72). Only 14 percent are in riskier assets such as bonds, stocks or toshin (the remainder is in miscellaneous assets). In contrast, in the U.S. 36.3 percent of private assets is in equities, 31.4 percent in insurance and pensions, 11.5 percent in mutual funds, 10.1 percent in cash and bank deposits and 8.4 percent in bonds (the remainder is in miscellaneous assets).

A 60-40 split, say, between savings and investment products, in lieu of today’s 85-15 breakdown, would bring about ¥340 trillion into the markets, more than enough to spur a new bull market. As Shiroh Akiyoshi, the head of retailing strategy at Nikko Securities Co., notes, a 10 percent allocation to mutual funds would give Japan a ¥130 trillion fund industry within five years, more than double its current size. That would be enough to support the 76 investment trust management companies (including 38 foreign firms) that have piled into Japan’s fund industry since it was deregulated in 1991.

The Postal Savings Bank’s success is only the latest indignity for Japan’s equity fund industry, which has endured a truly bleak ten years. Clifford Shaw, chairman of Merrill Lynch Mercury Asset Management Japan, the third-largest foreign fund manager in Tokyo, refers to this period as the “lost decade,” in which Japanese funds marked time while European and U.S. equity funds raced ahead.

The numbers tell the story. At the end of March, the total value of Japanese mutual funds reached ¥54.9 trillion, marginally below the peak of ¥58.6 trillion attained at the height of Japan’s asset bubble in late 1989 (see graph at right). While returning to levels not seen since Japan’s boom might not seem so bad, Shaw and others point out that the overall numbers obscure the true picture of the equity-based funds.

Back in 1989 equity products made up three quarters of the total mutual fund pool, with bond funds accounting for the remainder. Today’s market is almost the reverse, with more than 70 percent in bond funds. The bond fund portion also now includes low-risk money market funds, used mainly by institutions, that didn,t exist in 1989. In other words, the pie is the same size as it was more than a decade ago, but it’s being divided three ways rather than two. And the equity slice has narrowed by nearly two thirds. “With that kind of breakdown, you can,t really claim that Japan is experiencing a mutual fund boom,” says Takeshi Hinata, vice chairman of the Investment Trusts Association of Japan.

The best that can be said is that equity funds have rebounded since 1997. At that point they were down to just ¥9 trillion out of a total mutual fund asset base of ¥40 trillion, or 22.5 percent. In 1989 equity funds alone totaled more than ¥45 trillion. Hinata says he hopes to see equity funds back on par with bond and money market funds soon, though he concedes that even this breakdown would only give Japanese equity funds a share comparable to what U.S. stock funds had a decade ago. A shift to a more aggressive 50 percent share for equity (with bond and money market funds splitting the remainder), as in the U.S., isn,t in the cards anytime soon, fund officials admit.

Even if the past year hasn’t met the most bullish expectations, the Postal Savings Bank’s unexpectedly high retention rate isn,t entirely a disaster for the funds. After all, 25 percent of the deposits are leaving the bank, though most seem headed to commercial bank deposits and money market funds. And some of the more liquid, short-term deposits reinvested at the bank may be up for grabs when they mature in the next year or two. There’s also a ¥10 million ceiling per customer for teigaku yokin, and any amount over that must be directed elsewhere. Some of that may find its way to equity funds. “Over the next two years, we think we may be able to attract as much as ¥30 trillion of the Postal Savings Bank money,” says Hinata. The typical 1.5 percent fee on that ¥30 trillion, which would represent about a 50 percent increase in mutual fund holdings, would certainly help fund managers.

Asset managers can also point to signs that Japan,s conservative investment culture is beginning to change. In February Nomura Securities scored a remarkable coup with the successful launch of its Big Project-N balanced equity fund, aimed directly at savers like Koide. The firm ran a catchy TV commercial in which a private detective, Kindaichi-san, the hero of a popular series of 1930s stories, advised a wealthy family that he had solved the “mystery” of what to do about low interest rates. Not surprisingly, the solution was a Nomura equity fund.

The ad worked. Big Project-N sold ¥700 billion worth of units in the three weeks before the day it started trading, ¥300 billion more than any previous fund sold or managed by the Nomura group. By mid-July the fund had hit ¥1.1 trillion, about two and a half times the size of the next biggest equity fund in the Tokyo market.

Aside from the inflow of money, “what really amazed us,” says Shuji Madono, the deputy head of the retail sales strategy department at Nomura, “was that we had people queuing round the block to buy the fund at branches all over Japan.” That had never happened before, even at the height of the 1987 to 1989 Tokyo bull market.

More intriguing was the age of the people in the queues. A majority of the 300,000 people who bought the fund were in their late 50s or older. This is a group that controls 70 percent of the savings pool and has been fiercely cautious. The success of Big Project-N, Madono says, suggests that older people are finally realizing that they can tolerate some risk. If he,s right, Japan may yet mimic the experience of a European country like Italy, where the share of savings held in mutual funds roughly tripled between 1996 and 1999, to more than 10 percent.

Although a number of Nomura’s competitors claim that the fund’s success was the result of a well-orchestrated sales effort, the ad clearly resonated with an older audience familiar with the Kindaichi-san character. Playing on Japan’s widespread nostalgia for simpler times proved to be an effective marketing strategy.

While Nomura was able to draw out older Japanese in a way not seen before, other firms are detecting signs of ferment among investors of all ages. Even some bankers, who have the most to lose if savings tilt toward investment, concede that their customers are getting restive about low interest rates. “Since the fall of 1999, there has been a huge increase in the number of people coming into our branches to ask what they can do with their money,” says Yoshinobu Nakama, a manager at the retail banking development division at Bank of Tokyo-Mitsubishi. The balance of fixed-term deposits held by commercial banks fell from ¥30 trillion at the end of January 1999 to ¥28.9 trillion at the end of May of this year, suggesting that low rates are pushing some customers to seek alternatives.

And then there’s the sudden popularity of foreign-currency-denominated savings accounts, such as the one Koide uses at Citibank. Nakama’s colleague Akira Miyazawa reports frenetic activity by holders of foreign currency deposits, with the amount of funds held in dollars by the bank’s retail clients doubling over the past year and account holders trading far more actively. “When the yen shifted against the dollar by half a yen or so, it used to take most people a day or two to react, but now we get customers phoning in with trading orders immediately after the midday news on NHK [Nippon Hoso Kyokai, the publicly owned TV channel],” says Miyazawa. Koide notes that she often waits until after an 11:00 p.m. TV program on forex activity in New York and London before shifting funds around in her Citibank account.

Miyazawa has also noticed a change in demographics among the participants. Female customers like Koide are becoming much more visible in shifting money in and out of yen- and dollar-denominated deposit accounts. “People doing forex deals used to be about 70 percent men and 30 percent women, but now women are much more active,” says Miyazawa. While the executives at Bank of Tokyo-Mitsubishi haven,t seen any dramatic move from savings to risk assets, the experiments with more volatile instruments indicate that frustration with existing savings and investment instruments is running high. Whether they are a prelude to more meaningful shifts is anyone’s guess.

Certainly, the willingness to try new approaches goes against the long and deeply ingrained conservatism in Japanese investment habits. Fumiko Konya, an economist at the Japan Securities Research Institute who has become a well-known investment guru on TV talk shows, says the Japanese are inherently more cautious about money than Europeans or Americans, particularly if they are 60 or over. “It’s not just that older people went through tough times after World War II and were exposed to a savings culture that was deliberately fostered by the government,” says Konya. “You have to remember that Japan is an agrarian nation, or was until a generation ago. Rice farmers have to live with acts of God like typhoons, so they tend to see risk as a hostile element that they can,t control.”

Controlling risk is a central element in Japanese society, notes Konya. The famous system of cross-shareholding among big companies belonging to the same keiretsu, or diversified business groups, was created to protect salaried managers from the whims of uncontrollable shareholders. The popular Japanese practice of having documents recording important business decisions stamped with the hanko, or personal seals, of many executives at different corporate levels is another risk-avoidance device. The point is to ensure that no single person is blamed if a decision goes wrong. In the world of investment, the equivalent of the hanko system is putting money in the bank like everyone else.

If anything, the experience of the early 1990s may have hardened this conservatism among some Japanese. Shaw of ML Mercury Asset Management notes that the annual study of investment attitudes conducted by the Bank of Japan shows that in 1990, 37 percent of respondents cited “safety” as the most important consideration in choosing a savings or investment product. In 1999 nearly 56 percent put safety first.

Shaw thinks that securities industry conduct during the last bull market is responsible, at least in part, for the reluctance of Japanese individuals to invest in equities. “While the booming stock market of the 1980s provided rich pickings for brokers, private investors fared less well,” says Shaw. As a result, he thinks it’s only natural investors should be skeptical about putting money in equities today. “Mrs. Watanabe [the proverbial holder of the purse strings in the typical Japanese household] doesn,t lack common sense,” concludes Shaw, “but she has clearly suffered from a surfeit of advice from commission-oriented broker salesmen.”

Shaw isn,t the only foreign investment trust manager who has some reservations about the sales practices of Japanese securities houses. The mutual funds committee of the American Chamber of Commerce in Japan is preparing a report that will ask the government to impose stricter guidelines on the industry. One big problem is the practice of persuading customers to buy and sell funds rapidly rather than build up stable portfolios. This generates commission income for the securities firm but isn,t necessarily in the interests of the individual investor.

There are some signs of progress in cleaning up sales practices. Mikio Takada, head of marketing at Jardine Fleming Investment Trust and Advisory Co., the fourth-largest foreign toshin manager, sees improvements in the 18 months that banks have been permitted to sell mutual funds. More conservative by nature, banks don,t encourage customers to take quick capital gains on funds, and they,re more careful about warning customers of risks. Conversely, they are also not as adept at pinpointing opportunities. Banks, though, account for a modest 8 percent of the total value of toshin assets, and most of that consists of low-risk, low-return money market funds that are mostly held by corporations, not individuals. “Effectively,” says the manager of another foreign fund, “securities firms still monopolize retail sales of equity-based toshin.”

No doubt investors would be more willing to commit funds if they trusted the salespeople at the brokerage firms. But that alone won,t do the trick. There’s one very simple problem about trying to make toshin fly in Japan, says Peter Tasker, a former equity strategist for Dresdner Kleinwort Benson, who is based in Tokyo and started his own mutual fund management company, Arcus Investments, at the end of 1998. “We don,t have a bull market.”

Tasker notes that bear markets of the depth and duration that Japan suffered in the 1990s will damage investment psychology for years to come. And the recent market downturn “certainly isn,t going to end with a bang,” he says. Even if it does, investors will remain skeptical. Tasker believes a whole new generation may have to come along before Japanese investment attitudes change. “All we can say at the moment is that we are at the end of the Ice Age.”

Given the poor returns on Japanese equities, John Alkire, head of Morgan Stanley Asset & Investment Trust Management Co. in Tokyo, thinks asset managers must offer investors a broader product mix to succeed. Rather than flogging domestic toshin, the fund companies should include more foreign investment vehicles, so investors can diversify their risk. But there’s a problem there, too: With the volatile yen-dollar exchange rate and the U.S. bull market showing signs of age, investors are wary about the long-term risks of holding foreign assets. Currency volatility is one of the biggest single reasons that Japanese individuals have kept their money in the bank, says Rei Masunaga, deputy president of the Japan Center for International Finance, a government think tank.

There may be intermediate steps that fund managers can provide to make investors comfortable with both the funds and the markets. Eric Michel, president of State Street Global Advisers (Japan), notes that in France, where funds have had lots of success in the past decade, the rates banks offered on low-risk money market funds were about 2 percentage points higher than those provided by the post office system. The safety of the money market funds, coupled with the higher yield, was an attractive alternative to post office deposits. In Japan, on the other hand, such funds offer only marginally higher rates, on the order of 20 to 40 basis points, which isn,t enough incentive. “It’s natural that savers should want to move into low-risk MMFs before they take the plunge into equities,” says Michel, who believes that higher rates would produce a “massive shift of funds” out of the Postal Savings Bank.

In some ways the disappointments of the past year may be a blessing in disguise, prompting fund managers in Tokyo to develop products and programs that address the needs of individual investors. The environment favors the fund managers: Corporate and state pension funds may not be able to cope with a rapidly aging population, and the time-honored lifetime employment system is slowly disappearing. As Akihiko Usui, chief manager of the retail banking division at Bank of Tokyo-Mitsubishi, notes, the Japanese people have little choice but to start making their money work for them.

And there’s another golden opportunity coming. Parliament is expected to pass legislation in the fall session that will lead to the introduction in April of a Japanese version of the 401(k), the U.S. system of defined contributions. Toshin investments that are part of defined plans will benefit from tax deferment on capital gains. That will give asset managers another enticement to transform savers into investors.

Fidelity keeps the faith

If a messianic belief in your message can convert savers into investors, then Bill Wilder may single-handedly create a nation of shareholders. Since he was selected to lead Fidelity Investments Japan,s new mutual fund effort five years ago, Wilder has helped make his firm the 11th-largest Tokyo-based investment trust management company , Japanese firms included. Fidelity ranks fourth in the equity fund sector, partly because other foreign asset managers, including Goldman Sachs (Japan), have focused more attention on fixed-income products.

Wilder believes, first of all, in multichannel distribution. Fidelity funds are distributed by 38 Japanese securities firms, 47 banks and five insurance companies. He is also convinced that the 1990s were a “weird interlude” for Japan, not the end of the country’s long-running economic boom.

The Fidelity executive doesn,t need economists or equity strategists to inform his historical view, and in fact he is proud that Fidelity Japan has none on its payroll. His faith in the future is based on the high quality of Japanese management. “You only have to look at the Fortune 500 to see that 20 percent of the world’s most amazing companies are here,” says Wilder. “Japanese investors need to wake up and realize that it’s time to walk with a bit of a swagger.”

So why aren,t people putting money into toshin, the Japanese equivalent of mutual funds? Not because they are inherently risk-averse, says Wilder. Rather, it,s because Japanese securities firms haven,t cultivated the market properly. He believes that most Japanese brokers are more interested in maximizing commission income than in earning profits for their clients.

Wilder also faults securities firms for failing to educate investors. He recalls being asked by a Japanese investor at a seminar whether foreign equity funds were safe, because they might contain North Korean securities (there are no such securities). Correcting that kind of basic misinformation through educational programs shouldn,t be too difficult, he says. “Once it has been done, we can expect a fivefold increase in the size of the toshin market over the next five to ten years.”

Meet Ms. Watanabe

Mrs. Watanabe, the fictional housewife who oversees a Japanese family’s finances, remains as risk-averse as they come. But her daughter may be another story.

Masahiro Kida, editor-in-chief of Nikkei Woman, says young working women are much more open to an equity culture than their mothers are. Kida believes that his magazine’s 120,000 readers, mainly unmarried women between the ages of 25 and 35, have become increasingly attuned to equity opportunities since he published the first of a series of cover stories on “What to do with ¥10 million” two years ago.

Kida’s initial article focused mainly on fixed-term bank deposits and foreign-currency-denominated bank accounts. Now he delves into riskier subjects. The June issue of his magazine, filled with features on foot massage, DVD players and job-hopping via the Internet, offers a story on “minishares” , funds that allow purchases of as few as ten to 100 shares in blue-chip companies instead of the regular lot of 1,000.

The new attitudes discerned by Kida reflect generational changes. Until the end of the 1980s, a typical middle-class young woman, after graduating from a two-year junior college, would take a job with a big company as an OL, or office lady, and probably leave for an arranged married when she was about 26. Today such marriages are going out of fashion, and big companies are outsourcing secretarial work to save costs.

Kida’s typical reader is a 28-year-old woman who lives with her family and usually isn,t in any particular hurry to marry. She may be earning ¥3 million to ¥4 million ($28,000 to $38,000) per year, but she’s likely to be a part-timer under contract to an employment agency, so she gets paid only when she has work. “A woman of that type probably has a five-year investment horizon,” says Kida. That means she tends to be less interested in a bank deposit that pays 0.12 percent per year.

In Japan reticence remains a feminine virtue. Nikkei Woman’s June issue includes three equity investment case studies. In one a woman claims to have made a ¥4 million killing on Internet conglomerate Softbank Corp., while two others generated smaller gains on conventional blue chips. None was bold enough to give her real name.

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