Nomura Research Institute’s annual inquiry into the business outlook for Japan’s asset management providers is always a good read. This year it is even more so and is here.
Based on NRI’s yearly surveys of firms’ perceptions of the priorities they need to pursue, plus other non-proprietary data series and the expertise of a five-person team led by Sadayuko Horie, the new study points to several simultaneous shifts.
The customer base of all three elements of the business – pension funds, financial institutions and retail — are today in the throes of change while fast-moving developments in equities investment environments are demanding rapid and most likely perpetual adaptations in investment processes.
Yet Japan’s asset management sector has been slow, compared with those elsewhere, to deploy the capabilities of artificial intelligence to deliver what clients needs.
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So far it has not suffered much from this failure. It ended the most recent financial year on 31 March 2016 with both assets under management and fee income hitting all-time highs of 1,856 trillion yen and 760 billion yen. respectively.
This climb came despite foreign asset holdings falling in value when translated into yen thanks to a 6.5% rise during the term in the yen against the US dollar. The current year will most probably see a reversal of that trend, flattering results.
Pension funds have been undergoing extensive restructuring since 2002. So far this has taken little asset management business off the table but it has seen the task of awarding mandates pass into the hands of more sophisticated sponsors who are already venturing into doing more of the job themselves.
Corporate and government-managed retirement schemes together form Japan’s largest body of institutional investors with over assets of over 305tr at 31 March 2016 – 7.2% lower than 12 months earlier. The vast majority are now dependent on income from those assets to pay the bills as they have passed the tipping point at which annual benefits payments start to outweigh income from contributions.
Since 2002 corporate sponsors have
- Closed all of the once 60,000+ Tax-Qualified Plans (TQPs) and either reconstituted them as other types of scheme or put their assets into one of the portfolios run for a series of industries by the Smaller Enterprises Retirement Allowance (SERAMA) whose component coffers thus swelled mightily to reach over 4.5tr yen. About one third of this – all in Japan government bonds — is today managed inhouse.
- Shut all but 147 of the formerly 1,800+ companies Employee Pension Funds (EPFs), converting them to a different type by handing over to the Government Pension Investment Fund that part of their portfolios (the daiko), which they managed on behalf of the official Employee Pension Insurance scheme. GPIF thereby became the world’s largest pension fund.
Also in the government sector, the mutual aid associations (MAAs) which invest civil servants’ retirement plans, have also been restructured with their daiko components separated out, benefits reformed and an agreement that they will follow much the same asset allocation as GPIF, once again increasing its market power.
PFA to manage more
Now the Pension Fund Association is offering today’s 14,500 corporate sponsors a low-cost pooled asset solution via a balanced portfolio that includes alternatives (infrastructure, real estate, hedge funds) and has an assumed rate of return of 2.6%. This is slightly higher than the 2.0-2.5% which corporate DB plans typically assume.
The PFA already handles a 11.5tr yen portfolio holding the assets of employees who have changed jobs and thus their employers’ schemes. While 60% of this is mandated to outside asset management firms, the Association runs inhouse the remaining 40% (which covers 60% of its domestic and 25% of its foreign bond holdings).
By aggregating assets from small funds, the new service could create pools which are large enough to be invested via specialist mandates for the first time and so increase the flow of business to asset managers.
However NRI takes a less sunny view of this development noting that it may also consolidate the management of smaller, manpower-constrained DBs’ assets in the hands of few providers. If that happens the largest impact seem likely to be on the pooled pensions businesses of life insurers and trust banks.
GPIF currently manages inhouse almost all of its passively held domestic bonds portfolio which makes up 36% of the massive 132tr yen total. It has made its ambitions to manage more, including equities, very well known and has been staffing up to do just that while it awaits the go-ahead from the legislature.
Firms offering asset management services will accept these changes gracefully for fear of losing other business from GPIF and the PFA — both which are arms of the Ministry of Health, Labour and Welfare, the pension funds regulator.
Among financial institutions demand for asset management services comes mostly from banks and insurance companies upon whom waves of change have been thrust by dire demographics, two decades of deflation and 20 years of repeated restructuring . (For graphics mapping the shifts see — Japan’s consolidating banking system and Japan’s shrinking life insurance sector — under Reference Points in column at right).
And now along come negative interest rates.
City banks, regional banks and what are often dubbed “second-tier regional banks” taken together had 240tr yen in investment securities holdings at 31 March 2016, 5.5% down a a year earlier.
Declining demand for credit means that banks, like pension funds, need returns on investments to shore up their earnings bases. With Japan Government Bonds now yielding nothing, their holdings of JGBs are limited to what they need for prudential purposes and other securities — domestic and foreign equities and overseas bonds – must pick up the slack.
However the NRI survey found that, except for some major institutions, banks “lack the resources to to upgrade their portfolio management capabilities to accommodate broader diversification…. And … 90% of respondents cited upgrading/refining risk management as a priority”.
The study notes that banks expect asset management companies to support them in this diversification drive and “to closely communicated with them after they have invested in [the firms’] products”.
Life insurers had 302tr yen in investment securities at the end of the most recent financial year, 1.1tr yen more than 12 months before. By the second half, however, they were seeing a drop in earnings income as interest rates on domestic bonds declined and interest and dividends due from foreign holdings were eroded by the rising yen.
By suppressing the value of their holdings, the same factors have eaten into life cos’ net unrealized gains which have supported much of their increased appetite for risk in recent ears and seen them invest increasingly in overseas securities. This is a factor, says NRI, “bears monitoring”.
The largest life cos are nonetheless very big investors and are gaining confidence in going abroad by buying overseas firms. However, the locations with the best opportunities for selling insurance are not necessarily those which offer the best investment securities.
NRI suggests that “with their investment needs expanding beyond traditional asset classes, life insurers will presumably outsource asset management on a larger scale then previously, predominantly in credit, emerging markets equities and alternative asset classes”.
In the retail segment all is calm on the surface but the undertows are becoming quite strong with the newer product-distribution channels claiming larger market shares.
Clients used to buy and sell investment trusts (called mutual funds elsewhere) solely through the securities companies which created and managed them.While this channel still dominates exchange-traded ETFs in particular are seeing increased flows.
At the March 2016 year-end the sector had 88.8tr yen of assets, down 8.3tr yen year-on-year with the bulk in public equities trusts. About 65% were bought through what NRI calls this “conventional” route. Five years ago this was 90% (see chart alongside for more)..
Some of the drop seems to be attributable to the inevitable fall in the value of so-called monthly dividend funds which used units-holders’ capital to make payments to them when income from the invested companies was insufficient. The study concludes that these vehicles “may never recover their former levels”.
Wrap (or “discretionary managed”) accounts are making slow but steady progress., Introduced 10 years ago they are sold by banks who prefer the regular fee income they provide to the one-off sales commission on mutual funds.
Units designed for defined-contribution (DC) pensions have also seen slow growth since this type of retirement scheme was introduced 15 years ago when only employers were allowed to make contributions. A May 2016 law extended eleigibility to employees and others, offering more opportunities for expansion.
Conversely, the growth in Nippon Individual Savings Accounts, available since January 2014, is already beginning to deteriorate. NRI survey data suggest that NISA inflows will be around 3tr yen annually for the next three years but may then cease on a net basis as their tax advantages end in January 2019 when assets should be around 12tr yen with about 8tr yen in investment trusts.
The study ends by noting that: “[Asset management companies] must boldly adapt to … changes in the environment and differentiate themselves from competitors … Whichever path they choose … they will undoubtedly have to develop new investment strategies to thrive in a competitive environment vastly different from what they have hitherto known”.
© 2016 Japan Pensions Industry Database/Jo McBride. Reporting on, and analysis of, the secretive business of Japanese institutional investment takes big commitments of money and time. This blog is one of the products of such commitment. It may nonetheless be reproduced or used as a source without charge so long as (but only so long as) the use is credited to www.ijapicap.com and a link provided to the original text on that site.
This blog would not exist without the help and humour of Diane Stormont, 1959-2012