Wealth Managers Grapple with Japan's Shifting Generations

November 10, 2010


Walter Altherr,
Executive Director, Equity Research, Global Financials, Mizuho Securities USA, Inc.
Oki Matsumoto,Representative Director, President and CEO, Monex Group, Inc.
Alicia Ogawa
,Adjunct Associate Professor, School of International and Public Affairs; Columbia University

Fred Katayama
,Anchor, Thomson Reuters; Director, Japan Society


A distinguished panel of financial markets experts joined forces at Japan Society to explore the changing dynamics of retail investing in Japan.


Many common beliefs about wealth management in Japan are ripe for challenge, not least the assumption that everyone in the country is middle class, Alicia Ogawa of Columbia University said. "When I first arrived in Tokyo in 1986, if you were to board a commuter train, you would assume that everyone bought their suit at the same department store, and everybody did look very middle class. Everyone had the same kind of comfortable appearance. If you ride the trains today, that is absolutely not the case."


Japanese households do put most of their savings in the bank, but "when you consider the rate of deflation and the lack of credit risk, it's actually not a bad deal," she added. The reason people haven't moved their savings elsewhere, in her view, is that "the domestic fund management industry, which might otherwise do a more creative and active role in increasing the wealth of the nation, has failed the population miserably."


During the post-bubble years of the 1990s, "you had a kind of class structure develop in Japan between people who are in this sort of permanent big-company employment system and people who are not—people who, because of reductions in force, because companies were not hiring when they graduated college, never had the opportunity or the experience of being involved in this lifetime employment system, and those workers now count for about one-third of the labor force." At 15.7 percent, Japan's poverty rate is not far below the U.S. rate of 17 percent. Some half million people in Japan have no access to pensions or even social security, a number that's expected to rise to 760,000 over the next three years.


Thirty percent of the Japanese workforce is over 65, and the government projects this will grow to 40 percent by 2040, Professor Ogawa said. "The biggest increase in employment over the last three years has come from people over 65 for whom obviously pensions and savings are not enough to support themselves. So, we're looking at a net wave of dissaving over the next five years as the wave of baby boomers begins to retire, and as [the share held by] elderly households, which now make up 23 percent of total households in Japan, becomes even higher." With 95 percent of the Japanese government bond market held domestically, "we're looking at a possible stress, if I can be polite, on the JGB market as this begins to happen."


The growing income disparity in Japan is due to the well-off becoming wealthier, partly because of a recovery in asset values, and partly because "more and more people are working for foreign firms who pay for performance, and in particular the securities industry, where all the thriving firms really are foreigners." Japan today has more high net worth individuals than anywhere else in Asia, representing 54 percent by population and 40 percent by wealth, and holding almost $4 trillion in assets. "The bad news is that China, India and Thailand are all growing at a much faster rate in terms of high net worth business."


Regulators in Japan have "done a fantastic job" of clarifying financial industry rules and clamping down on regulatory violations, which had gotten the private banking business off to a rocky start, she said. Foreign firms, in particular European firms, "are very eager to access this business, which seems mostly geared towards reducing taxation, particularly inheritance tax, and allowing for a greater range of investment opportunities than otherwise might be the case in Japan."


In Japanese asset management units, most executives rotate through, as with any other corporate department; they are generalists, not specialists. "Certainly nobody is paid for performance. So, there is no incentive really for a fund manager to strive to do something new or to try to actively manage, even if it's in a passive way, the assets under his control." Moreover, "there is no tradition of financial training in business schools in Japan, although that is changing," Professor Ogawa said. Exemplifying the problem, a Tokyo University professor recently told her that he'd tried for the past three years to find someone to teach securities analysis in his financial management course, but without success.


Retail investors in Japan have "a deep distrust of the big financial institutions," Professor Ogawa concluded. "There is a deep distrust of the government and the bureaucrats who run that financial industry. And there has been a real profound lack of response on the banking and fund management side to provide individuals with a safe, transparent way of managing their money, or at least a range of alternatives for them to choose from."


JGBs offer very low, indeed inadequate, interest rates because of a very simple fact, said Oki Matsumoto of the online financial services company Monex Group: Japan's annual budget is a trillion dollars, but it takes in only about $500 billion a year in tax revenues. To make up for that shortfall, "the government needs to push retail people to make deposits into banks and the Post Office so that the banks and the Post Office can buy JGBs. That's how the money is being pushed."


In his view, the government needs to raise taxes, and households need to find better destinations for their savings—first, to earn a better interest rate, and second, to diversify their holdings. "Putting all their money into yen is a very dangerous thing I think for [retail investors] to do. There are many different opinions, but to me it is very difficult to believe that the yen is going to keep strong for long."


"Some time in the near future, China is going to have to finance the reserves in the international capital markets," and at that point, people who currently park their money in JGBs will sell them and buy Chinese government bonds, Mr. Matsumoto said. Big financial institutions, he added, are unlikely to make changes in this direction any time soon, given the key role they play in realizing the government's policy aims with respect to the JGB market. But retail investors must diversify into investments outside of Japan, whether in equities or fixed income securities. "I don't care what the government thinks about it as long as we are not punished by the FSA," the Financial Services Agency, he concluded. "That's how we think we can change, and we will change, how the Japanese retail money will be managed going forward in Japan."


When Walter Altherr of Mizuho Securities USA began working at a brokerage firm in Japan in 1992, his background was in commercial banking. There was a torrent of information available every day in the newspapers, and he was determined to make sense of it. But the advice he got from colleagues was somewhat conflicting. Some people told him to pay attention only to views of the Japanese people in the company, while others advised him to pay attention only to the views of the foreigners.


He concluded that the two schools of opinion were based on contrasting assumptions about the nature of Japanese business culture. On the one hand, Japanese business people, who were experts in the myriad rules and customs on how things are done in Japan—many of them unique to Japan—looked at foreigners who hadn't mastered these arts and decided that "'the foreigners don't really know what's happening.'" Implicitly, they assumed that Japan would not change in any meaningful way.


On the other hand, many of the foreigners coming to Japan had other international experience, and "knew broad patterns for how markets worked in other places. Many of the Japanese, being a little bit more provincial, weren't aware of it, and so the foreigners said the Japanese didn't understand what was going on." And the foreigners implicitly assumed "that Japan would converge—basically, they would finally get their act together, join the party, and become like the rest of the world."


In certain respects, the convergence that foreigners expected has taken place. Thirty years ago, a fund manager in Japan who wanted to buy five-year paper had a very small menu to choose from: debentures offered by three long-term credit banks. When buying a debenture of a given term, yield and duration, "they wouldn't specify which issuer they were going to get. They wouldn't know until the next day when the order cleared what they'd actually purchased." All had identical terms, and managers viewed all three banks as having zero default risk. Two of the three banks were eventually placed under temporary government controls. Japanese practices had to change.


In other respects, "It is, I think, much of the West that has become like Japan," with tumbling real estate prices, concerns about financial system solvency and widespread voter disaffection, Mr. Altherr continued. Mrs. Watanabe, who stuck to bank deposits when the studies agreed that equities offered the only chance to make a fortune, "was maybe smarter than a lot of these foreign strategists."


Offline retail brokerages have not fared well over the last 20 years in Japan, he continued. Returns on equity securities haven't been very good. Risk has been high. Internet and discount brokerage firms have challenged the traditional equity model. As for fixed-income securities, the basic business model of the intermediary, whether it's offering a bank account or an insurance product, stops working when interest rates decline towards zero. "You can't really take that person and say, 'We're a zero interest rate environment, so your yield on your deposit is negative 1 percent.' People aren't stupid. They would just put their money into a safe deposit box."


With the Big Bang in the late 1990s, restrictions on foreign securities began to be eased, and "a lot of Japanese money began going abroad" into high-yielding instruments and high-growth equities. Much of it was invested in resource-related countries, Australia, Canada, South Africa. This "has gone out well I think for most of the last decade. It remains to see how it will go in the future," Mr. Altherr said.


Foreign equities are an area where offline brokers have something of a competitive advantage in Japan, he concluded. This is because they can offer more personal attention to customers, many of whom will be unfamiliar with overseas investments.


Moderator Fred Katayama of Thomson Reuters began the Q&A:


Should government stay out altogether in terms of the financial markets? Or is there a role for it to play?


"Government should be out," answered Mr. Matsumoto.


"Altogether?" asked Mr. Katayama.


"We don't need government. You've got the history of Japanese corporations. Whenever government tried to get involved, tried to protect—disaster," Mr. Matsumoto said. Electronics makers were left alone, and did well; the telecom and financial services industries were not, and they lost.


Professor Ogawa agreed, though she noted that the government "did actually prove to be a remarkably successful agent in rebuilding Japan after the destruction of the war."


As for alternatives, sovereign wealth funds aren't the answer, she added. "It's only substituting one form of government for the other." Nor are 401(k) retirement accounts as currently structured, because in Japan they are taxed, which eliminates the incentive to use them. And Japanese equities suffer from corporate governance problems, with public companies "not necessarily responsive to shareholders in the same way that companies in other countries would be."


Walter, Oki, do you think that corporate Japan has to change its mindset so that it puts higher priority on shareholder value as opposed to the focus on employees and customers?


"Personally, yes," Mr. Altherr replied. "My biggest fear if we saw government involvement would be that the government would establish a system where people would be required to set aside their savings, but would not have any vote at the corporate meetings. I think that one of the problems in Japan is we haven't really had shareholder democracy."


Shareholders should be the priority over employees, Mr. Matsumoto indicated. In time, Japanese corporations will come to possess a more global vision, and when they do, they will "have to relate with various stakeholders, including shareholders." Cross-shareholders don't vote in Japan, nor does the government—and "you have to somehow, ideally, get rid of them."


The choices are Japan's to make, Professor Ogawa said. "I think the problem is that people are not being clear about the choices they are making."


To remedy the holes in the pension system, Japan could allow immigration, though that option "is off the table always." Or it could raise the retirement age, or entice more women into the workforce, though the achievement of either of these two options seems doubtful. "If Japan wants to become a declining population, a declining standard-of-living country, that is their choice. But let's be clear that that is the choice you're making."


How vital is it that the Japanese put their money to work abroad?


"The image that Japanese have got too strong a home bias is I think wrong," Mr. Matsumoto responded. In reality, every country has a strong home bias. The U.S. Social Security system puts all its money into government bonds, whereas the Government Pension Investment Fund in Japan has 8 percent in equities.


"Can I respectfully disagree?" asked Professor Ogawa. Countries such as the UK, Belgium and Italy have net savings in excess of the size of the economy, and have long been accustomed to dealing with other countries because of their history of colonization. They also are smaller than the U.S. and Japan, so they are forced to try to invest overseas.


What should Japan do to better educate the public and financial professionals about investing?


"I think that the first thing that has to be taught is that it's okay to take risk, and it's okay to fail. I think that's much more important than learning the theoretical payoffs of corporate finance and leverage," Professor Ogawa said.


When foreign companies have taken over joint ventures in Japan and tried to adopt incentive pay systems, it hasn't worked, Mr. Altherr said. The top earners were embarrassed to be paid so much more than the bottom earners, so the spread between the top and the bottom narrowed to no more than 3 or 4 percent. "Particularly for the younger generation, we have to break that concept that, if you will, all three of the long-term credit banks are equal, everyone is equal. There is risk, there is differentiation in so many areas of the financial system and financial investments, and that's something that we have to teach."


Before all else, Mr. Matsumoto said, the Japanese public has to be educated about fiscal policy. As personal financial assets in Japan grew from $8 trillion to $14 trillion, Japanese government debt grew by $6 trillion. "We, the Japanese, are kind of shareholders of the country," but it would be absurd if a company issued a bond and owned it and then said, "our assets have grown."


The audience members asked:


No major bank has its Asian headquarters of asset management or private banking in Tokyo. What does Japan have to do to regain competitiveness against Hong Kong and Singapore?


"My personal opinion is that Japanese, I think, tend to feel very uncomfortable talking about his or her personal financial assets with a Japanese advisory. Sometimes they feel more comfortable talking to non-Japanese," Mr. Matsumoto answered.


What are the reasons for the strength of the yen, and what are its repercussions?


"In times of financial turmoil you almost always see Japanese companies, and particularly Japanese financial institutions, repatriate, even if it's not necessarily logical. There have also been reports of the Chinese diversifying their portfolio into yen. The interest rate differential between the U.S. and Japan has closed, but it still exists," Professor Ogawa said.


If people were to trade yen today and then couldn't trade again until five years from today, they wouldn't be in yen, Mr. Matsumoto said. But you can trade foreign exchange every second, and "people just bet on the market."


"Everyone can agree that at some point interest rates are going to go crazy in Japan, but it's very difficult to point to a specific catalyst that will make that happen," Professor Ogawa commented.


"I think this is the difficulty of people shorting either the equity market or the Japanese government bond market is that rabbits that can be pulled out of a hat. Like in the bond market, we can always increase the amount of money you could put in the Post Office, or we can always loosen the guidelines for the Government Pension Investment Fund, or they can borrow money so they don't have to sell yen. The creativity of the Japanese in terms of postponing crises is infinite. I'm in total admiration for this," she said with affection.


Katherine Hyde

Topics:  Business, Policy

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