When Mizuho Securities Equities Research opened its doors in October 2000, Japan’s bear market was a decade old. Over the next three years, Mizuho, part of a huge financial services conglomerate formed through the merger of Dai-Ichi Kangyo Bank, Fuji Bank and Industrial Bank of Japan, more than doubled its equity research staff, to 44 analysts. Several European banks, including ABN Amro, WestLB and Commerzbank, shut down their Japanese equity operations. American powerhouses Merrill Lynch & Co. and Morgan Stanley substantially cut back theirs. Mizuho’s expansion was a show of faith -- and ambition -- in tough times.
“We were building the ship when it was a very stormy market,” says Ken Yokohama, Mizuho’s director of equity research.
Today Mizuho is sailing in calm seas with a brisk wind at its back. Just last month Standard & Poor’s raised its economic outlook for Japan to stable from negative, validating the more positive assessment many investors have had for a year or more. Since March 2003 the Nikkei 225 index has risen 44.3 percent; it poked through 11,000 last month. Foreign investors pumped ¥10.8 trillion ($10 billion) into Japanese shares in the fiscal year that ended March 15, more than 30 times the amount they invested in the stocks in fiscal year 2003. Japanese investors who all but stopped buying domestic stocks in 2001 and 2002 have stepped up their investments, often through global money managers such as Crédit Agricole Asset Management, Deutsche Asset Management, Fidelity Investments and Goldman Sachs Asset Management. All have established Japanese affiliates that are beginning to compete successfully with indigenous firms for both retail and institutional accounts.
A few years ago these foreign giants might have sought out Japanese equity research from big Western firms, with whose language, culture and even accounting methods they were most familiar. Now they are just as likely to turn to Japanese firms like Mizuho, Nomura Securities Co., Daiwa Institute of Research and Mitsubishi Securities Co. Yokohama says that Mizuho’s client base is 70 percent overseas investors. His goal is to create a research group that can offer non-Japanese customers a broader view than that of the typical Japanese bank. Remarks Nagamichi Fujioka, managing director of Nomura Securities’ equity research department: “There’s no great difference between us and foreign houses. Our research objectives are the same and our clients are the same.”
Investors agree. Led by Japanese powerhouse Nomura Securities, local firms greatly improve their standings in this year’s Institutional Investor All-Japan Research Team, the 11th annual survey of the best Japanese research.
Every Japanese firm maintains or improves its position in II‘s 2004 ranking. Nomura, which as recently as 2001 ran second to Morgan Stanley in Japanese equity research, takes the crown for the ninth time in 11 years. Nomura’s 21 team positions are one more than it had in 2003. Daiwa Institute climbs six places to third, gaining seven team positions for a total of 16. Yokohama’s Mizuho Securities rises two slots to tie for eighth place, and Mitsubishi Securities improves three notches, to tenth.
Four of the top ten brokerages in this year’s team are Japanese firms, in addition to the Japanese-American hybrid Nikko Citigroup, which most investors view as a foreign firm. Last year three of the top ten were Japanese, up from two in 2002. Overall, Japanese brokerage houses win a total of 55 positions, up from 38 in 2003. In contrast, foreign firms fall back, snagging 85 spots on the 2004 roster, versus 89 a year ago. Morgan Stanley Japan drops from fourth place in 2003 to seventh this year, with just 12 team positions. Nikko Citigroup, which last year tied Nomura for the top spot, drops three notches to tie for fourth with Deutsche Securities, which itself falls one place. Credit Suisse First Boston falls from sixth place last year all the way to 11th, losing seven team positions. Merrill Lynch Japan Securities Co. slides from seventh place to a tie for eighth. And J.P. Morgan Securities (Asia) slips one spot to a tie for 12th.
Some foreign firms manage to climb in the rankings this year. UBS, continuing its global buildup, climbs three spots to second place in 2004 with 19 team positions, up from 14 in 2003. And Goldman Sachs (Japan), seventh a year ago, leaps to fourth this year with 15 team positions (up by four from last year), tying with Nikko Citigroup and Deutsche Securities.
A number of foreign investors openly favor Japanese firms, citing their superior local resources. Nomura alone has about 60 analysts covering Japan; Deutsche Securities employs about 30 in Tokyo. Nomura’s bigger head count allows it to encompass many more of Japan’s small- and midcap companies. “The strength of domestic houses is broad and thorough coverage,” says Shizuko Ohmi of SG Yamaichi Asset Management Co., which manages nearly $15 billion.
Edward Brogan, who manages Tokyo-based Whitney New Japan, a $750 million hedge fund, says senior analysts at local firms enjoy an advantage over foreigners in knowledge of Japanese companies. “In many cases they’ve been covering the sector for a long time, they’re familiar with the industry, and they’ve seen it through various cycles,” he says.
Mizuho, backed by the resources of one of the world’s biggest banks, has used the recent cutbacks at foreign firms to increase both the scope and size of its research staff. Its ranks have been filled out in part by hires from foreign brokerage houses. Other Japanese firms, such as Mitsubishi Securities, have also gone bargain-hunting for talent.
Standing still can also mean moving forward in today’s austere research climate. Masatoshi Makino, research chief of Daiwa Institute, which has kept its roster of roughly 50 local analysts intact, reports that investors have taken more notice of his firm because it has stuck to its analyst development program. “Our policy is to train and treasure analysts as valuable long-term assets,” says Makino. “We don’t hire analysts to exploit their capabilities for, say, two years during a bull run, only to fire them with a reversal of market direction.”
Foreign firms continue to flock to Narita Airport for the flight home. The number of foreign securities firms registered to operate in Japan, according to the Japan Securities Dealers Association, fell from 58 in March 2000 to 40 in March 2004, the result of Japan’s slow-motion economic decline since the late 1980s, coupled with regulatory and compliance problems -- not least strictures placed on equity research departments by Wall Street’s landmark $1.4 billion settlement with New York Attorney General Eliot Spitzer in 2002.
Another factor, says Timothy Taylor, co-head of equity research for UBS in Tokyo, is the increasingly competitive marketplace in Japan. Japanese investors are directing more of their commission business to fewer brokerages so that only firms in the very top tier can turn a profit. “So the real question is: Do you want to be [among the top brokers]? Because if you’re not there, it’s quite unprofitable,” says Taylor.
Investors increasingly worry that Japanese stocks are no longer adequately covered, as foreign firms cut back. “There are fewer voices now, and that has had an impact on overall quality,” says Whitney’s Brogan. “There are just fewer analysts.” Others complain that American firms have been distracted by the implementation of new policies to ensure analyst independence.
“It’s been a difficult year adjusting to all the regulatory changes,” contends Anthony Carpet, co-director of pan-Asian research at Goldman Sachs (Japan) in Tokyo. But he’s quick to add: “We’re committed to the highest standards globally.”
Japanese firms are facing disruptions of their own this year. Japan’s self-regulating securities dealers’ association is considering banning sell-side analysts from making investment banking pitches, among other measures. The rules will mirror those in the U.S. and “clearly divide the Japanese investment banking and brokerage businesses from a research point of view,” predicts Nomura’s Fujioka.
Despite regulatory distractions, some foreign brokerage houses have profited by building their local research capability. Like Mizuho, UBS is beginning to reap the benefits of “a fairly aggressive rebuild two years ago,” says Taylor. “We found ourselves in a rather fortunate position, in that we were trying to find people when others were not as focused on Japan.” Four of UBS’s ranked analysts were hired since late 2002: Three are from Merrill Lynch -- Takaki Nakanishi (No. 1 in Autos in 2004, up from runner-up in 2003); Hitoshi Shin (second this year and last in Electronics/Industrial); and Fumihide Goto (repeating as runner-up in Electronics/Components) -- and one, repeat Metals first-teamer Atsushi Yamaguchi, is from J.P. Morgan Securities. A well-respected telecommunications researcher, Makio Inui, joins UBS this month from Nikko Citigroup. (Inui’s hiring was after the magazine’s February 6, 2004, cutoff date for job-hoppers, so his second-team finish this year is credited to Nikko Citigroup.)
Watching costs was an overriding theme at every brokerage house, even UBS. The Swiss firm’s Tokyo equity research staff actually fell by 8 percent. “We canceled a few vacancies and didn’t replace people who left,” explains Taylor. UBS lost a couple of highly regarded analysts to the government’s Industrial Revitalization Corp. of Japan and an additional pair to a hedge fund. More buoyant markets have led to stronger demand for Japanese analysts recently, however. “Absolutely everyone is hiring now -- or so I’m told,” says UBS’s Taylor.
Perhaps the most notable casualty of the reconfiguration of Japanese research is the expatriate analyst. These intrepid foreigners started coming to Japan in the late 1980s to introduce international standards to local research and serve as liaisons to overseas investors. Working in Japan’s then-fast-growing marketplace gave expats insights into an important global economy and often served as a résumé-enhancer. More than one quarter of II‘s All-Japan team were foreigners as recently as 1996. Today just 6 percent of ranked analysts hail from overseas. Research directors estimate that there are no more than 50 foreign analysts working in Japan.
Many of the foreign analysts who stayed in Tokyo decamped to hedge funds, says Whitney’s Brogan. He himself was an All-Japan Autos & Auto Parts runner-up for two years before he joined hedge fund Tiger Management in 1998. Brogan recently lured two UBS analysts, Christopher Redl and Stephen Barker, the latter a runner-up in Health Care & Pharmaceuticals in this year’s All-Japan team, to join him at Whitney.
Other expats have abandoned Tokyo. A big reason: the money. “As the market has fallen, it makes less economic sense for these guys to hang out in Tokyo,” says Greg Jones, co-head of research at Deutsche Securities, whose entire staff of 30 analysts in Tokyo is Japanese. “There are more internationally qualified, bilingual Japanese analysts than a decade ago,” agrees Goldman’s Carpet. And, as other research directors like to point out, they cost a lot less than expats. Compensation for a Japanese analyst is usually 20 to 50 percent below that of a foreigner, once housing allowances and other considerations are taken into account.
The big global firms, such as Deutsche Securities, Goldman, Merrill, Morgan Stanley, Nikko Citigroup and UBS, all have one big advantage over most purely Japanese local rivals: the sheer sweep of their coverage. Most Japanese firms retreated from global research in the early 1990s and haven’t gone back. Even within Asia the Japanese haven’t kept pace, says Fuyuki Fujiwara, a principal at Tokyo-based hedge fund consultant Speedwell Advisors. “The bulge-bracket firms are either shifting to a regional approach or clearly recognize the importance of doing regional, if not global, research to analyze Japanese companies better.” The big foreign firms call him every day with views on stocks in mainland China, Hong Kong, India, Japan, Korea and Taiwan. “The Japanese brokers can’t do this,” he says.
Analysts, Japanese and gaijin, got a chance to strut their stuff in last year’s exuberant market. Financials/Banks first-teamer Hironari Nozaki of HSBC Securities (Japan) coaxed clients into Japan’s long-ailing banks shares: They went on a tear, soaring 59 percent in 2003. He was particularly impressive on UFJ Holdings. Nozaki continued to recommend the stock even as it dipped below ¥100,000 last April when there was speculation that the bank’s huge bad-loan portfolio might cause it to collapse or be nationalized. Nozaki told investors that UFJ’s fundamentals were still solid and that its results would improve as Japan’s economy revived. Recently, the shares jumped to ¥610,000 as UFJ unloaded more of its bad debt and earnings beat analysts’ estimates. (As this magazine went to press, Nozaki resigned from HSBC Securities to join an unnamed firm.)
Investors think the work of Nozaki and his peers at other equity research houses is generally improving. Institutional Investor asked the buy-siders who voted in our All-Japan Research Team survey to rate Japanese sell-side research on a scale of 1 to 10. Respondents awarded an average score of 6.44, compared to 6.19 last year.
Click here for the complete 2004 All-Japan Research Team
The All-Japan Research Team was compiled by Institutional Investorstaff under the direction of Assistant Managing Editor for Research Lewis Knox and Senior Editor Jane B. Kenney with Associate Editor Sivert Hagen and Researcher Katsuko Usami.
