A treasure trove of personal savings is about to be opened in Japan. Beginning in October 2007, more than 200 trillion yen ($1.7 trillion) will be removed from the postal system’s government-sponsored savings programs and placed in quasi-private accounts.
The impending flood has many asset managers thirsting after prospective new business. Given the sums involved, and the recent opening of the postal system to slightly more speculative investment vehicles, expectations are running high. In October 2005, Japan Post selected three asset management firms to begin distributing mutual fund products at 575 of its nearly 25,000 branch offices. In April, it will choose four more funds for distribution beginning in June.
Hideki Sotokawa, director of fund services for Standard & Poor’s in Tokyo, noted that savings in Japan Post have fallen from 259 trillion yen in 1999 to 203 trillion yen as of January 2006. He believes that the post office began offering mutual funds to keep its savers.
In the long run, Sotokawa said, Japanese savers will direct an increasing percentage of these monies to non-domestic bonds, including equities, global-fixed income securities, and mutual funds that invest in these asset classes.
The unleashing of such vast sums has provoked anxiety among private Japanese bankers and government bondholders due to the unknown effects on financial markets. Yet neither they nor the asset managers are likely to notice much of a change, at least at first, according to many experts.
“There is an extraordinary amount of inertia built into that money,” said Burton Greenwald, president of Philadelphia-based financial services consulting firm BJ Greenwald Associates. With the expansion of the asset management business, people are “not likely to be attracted by promises of growth, but initially by promises of stability, and perhaps a little extra income,” he said.
Government bonds have long been Japan Post’s predominant holdings. With the nation’s diligent savers accustomed to the security of their principal, despite negligible returns, many believe that this focus on bonds will continue. Indeed, 74% of the postal savings are in term deposits that must be invested in Japanese government bonds (JGBs), municipal, and government-guaranteed bonds, noted Goldman Sachs (GS) in its September 2005 report. Nearly two-thirds (63.9%) of those deposits are in accounts of three or more years.
The transfer of the public’s savings to private oversight has been incubating over the past several years. Deregulatory policies permitted banks to begin selling mutual funds in 1998, while defined contribution pension plans were introduced in 2001.
On Sept. 11, 2005, following the defeat of a postal reform bill, Prime Minister Junichiro Koizumi called early parliamentary elections and was re-elected in a landslide. He used the occasion to push through the reform in October.
Japan Post is actually the world’s largest savings bank, amassing private funds held by individual Japanese savers. In addition, it distributes insurance as well as the nation’s mail. (The Japanese government maintains a separate pension system into which individuals pay.) In all, it holds roughly 330 trillion yen ($2.8 trillion), which is significantly over half of the nation’s GDP.
Under Koizumi’s legislation, the postal divisions in 2007 will become separate entities under a holding company controlled by the government. At the end of a transition period in 2017, the state’s stake in the holding company, Japan Post Corp., will decline to at least one-third, with the balance of shares sold to the public. The savings will no longer be guaranteed by the government, but by a Deposit Insurance Corporation, into which the new company will pay.
Goldman Sachs projected that by year-end 2010, total mutual fund balances held through postal offices could total over $60 billion, if sales follow a pattern similar to that of the one that followed the lifting of the ban on bank mutual fund sales. However, it sees as little as $6 billion per year in Japanese savings moving into equities, assuming postal savings deposit assets into the stock market increase by 1% per year.
Some observers see these amounts as negligible. “It’s like a flashlight on a life raft in the middle of the Atlantic — good luck finding it,” said Jim Lowell, editor of Fidelity Monitor. “But if there’s nearly $3 trillion floating around, and you can hit it with products that relate to Japanese investors’ culture and objectives — a savings and income orientation — then you’re talking about a significant business opportunity,” Lowell added.
Of close to $13 trillion in Japanese household assets, mutual funds accounted for about 3.4% of assets at the end of 2005, or $436 billion, with equities another 11.4% ($1.5 trillion), according to preliminary Bank of Japan data for 2005.
Many observers expect Japanese investment firms to enjoy an advantage in tapping into the broadening Japanese market. Nonetheless, U.S.-based Goldman was one of the three firms selected by Japan Post to begin distributing mutual fund products through the post office branches, along with asset management divisions of domestic firms Daiwa Securities Group Inc. and Nomura Holdings Inc. (NMR) .
Japan Post made the choice from 31 management groups seeking the spots, based on a mixture of quantitative and qualitative criteria, said Sotokawa, who advised in the process as part of a team from Standard & Poor’s.
For its part, Nomura manages about $578 million in assets for the postal service in “hybrid” funds combining equities, bonds, and REITs, said company spokesman Yoshihito Suzuki. Although this is a fraction of the firm’s total Japanese retail business of $116 billion and it is not currently profitable, the company expects to reap “substantive benefits in the near future” from the postal business, Suzuki said.
The minuscule size of Japanese mutual fund holdings leaves significant room for growth in the business. The strong stock market of the past couple of years, in Japan and internationally, coupled with the interest rate differential between Japan and other countries, has rewarded retail investors who ventured outside of domestic bank deposits, said Standard & Poor’s Sotokawa. He believes that this experience is likely to encourage more such investments among the Japanese.
Greenwald foresees the creation of new investment products to target the savings pool, possibly combining U.S./Japanese companies. “Joint efforts have historically been the route in Japan,” he said. “The U.S.-based organizations have had a difficult time getting into that marketplace on the retail side, and this is retail money.”
Nomura’s Suzuki projects a growing role for equities, possibly outpacing bonds in the future, aided by the government’s encouragement to move household assets “from savings to investments.” “There are very strong bonds of trust between the Japan Post and the Japanese people,” he said. With the government putting its “stamp of approval” on certain funds, he said, “people may look at investing in a new light and be more accepting of it.”
While the bulk of postal funds are expected to flow into conservative investments such as bonds, U.S. firms aren’t positioned to get much of the bond business, said Lou Harvey, CEO of Boston-based financial services research firm Dalbar Inc. But Harvey sees U.S. equity firms as possessing a strong reputation and “cachet” over their Japanese competitors. “It’s not so important to understand research if you’re buying Treasuries and laddering,” he said. “But worldwide, U.S. firms are considered expert in equities, and that expertise matters.”
Major U.S. investment firms operating in Japan include privately owned Fidelity, whose legally distinct international division reported $32 billion in total assets under management as of January 31, including $13 billion in open-ended equity funds. Fidelity claims to be the largest foreign asset manager in Japan and sixth largest overall. Its flagship Fidelity Japan Growth Equity Fund is the biggest Japanese equity fund in the nation, said Sotokawa. A Standard & Poor’s contract with Fidelity to rate the fund expired in August 2005, said Sotokawa.
The company currently offers funds through Japan Post’s defined contribution pension plans, said Fidelity International spokesperson Tomoko Aikawa. “When Japan Post decides to offer actively managed funds, we will seek to provide a product that will suit Japan Post’s needs,” she said.
Lowell sees a role for money market funds as well. Because such funds represent Fidelity’s second largest asset class, in the U.S. and Canada (18.7% of assets as of February 28, according to Fidelity), it stands a good chance of getting that business in Japan, he said, helped by what he calls the company’s “profound affinity” for Japanese culture. However, Fidelity International’s Aikawa said that Japanese money market funds had “retrenched over the past few years.”
Franklin Resources (BEN) — the fourth-largest U.S. asset management firm, behind Fidelity — is also seeking an expanded presence in Japan. With $4.5 billion in assets as of year-end 2005, the firm currently runs four Japanese funds, including its $3.2 billion Mayflower Fund, a yen-denominated portfolio of U.S. government securities. The firm has been in the country for a decade, and in January 2001 received a government license to sell retail funds, said Vijay Advani, executive vice president of global advisor services. “Japan’s full-scale entry into the mutual fund business could be a driver of the mutual fund market expansion,” said Advani.
Past efforts by non-domestic money managers to infiltrate the world’s second-largest economy have met with disappointment. “I would put it in one word: futility,” quipped Harvey. “Many have tried, and been frustrated.” Firms such as Fidelity and Merrill Lynch (MER) have encountered obstacles that forced them to “reconsider their commitment to the market and find alternatives,” he said.
Jason Kendy, a spokesperson for Merrill in Japan, said that while the company entered the country 40 years ago and had never left, it had undergone “a substantial scaleback of retail brokerage operations we launched in 2001″ in order to focus on high-net-worth individuals and small and medium-size organizations. However, Merrill’s asset management arm continues to distribute mutual funds through third parties.
Fidelity International spokeswoman Aikawa said that since entering the country in 1969, Fidelity had focused on non-Japanese investors before receiving its license to sell mutual funds in 1995.
Other hurdles include meeting regulatory requirements. In late December, the Wall Street Journal reported that Goldman had been disqualified from participating in the expanded list of funds for April 2006, pending an order from regulators to strengthen its compliance and internal control systems. According to the Journal, the charges concerned the transfer of assets from one customer’s accounts to another, and an illegal cross-trade between two investment trusts to reduce expenses. The ruling does not affect the company’s existing fund that is being distributed by Japan Post.
Standard & Poor’s Sotokawa said that Goldman’s case is not unusual in Japan, where both domestic and foreign-based companies are monitored by the country’s Financial Services Agency (FSA). “If FSA finds illegal transactions, they make a public announcement and the company is forced to resign some public bids, such as in the Japan Post case,” he said. State Street Global Advisors, the investment arm of State Street Corp. (STT), currently faces similar scrutiny from FSA, he added.
A spokesman for State Street confirmed Sotokawa’s report. Goldman Sachs did not respond to a request for comment.
Hurdles notwithstanding, asset managers will continue to grab for a piece of the postal savings pie, Lowell said. He sees a difference between earlier efforts and the current one. Previously, “the impediments were more cultural — the business culture was more one of secretiveness than transparency, of keiretsus [cross-shareholding conglomerates] rather than audited entities.” Nor, in his view, were individual investors prepared to accept the mutual fund model.
“Companies likely to go back into this breach have already gone down this path before, and will go in equipped with significant street sense,” he concluded. And this time, select firms will be armed with what appears to be a government mandate.
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