As part of his Abenomics program, former Prime Minister Shinzo Abe, who took office in December 2012, compiled a growth strategy so that more households and public funds would invest in risk assets and growing businesses.
To get the ball rolling, an expert panel recommended in late 2013 to vitalize financial and capital markets, pointing out that nearly half of household assets — totaling around ¥1.6 quadrillion at the time — were held in cash and deposits. Public pensions are also holding massive amounts of Japanese government bonds (JGBs).
The panel described them as “inactive” funds and called for the implementation of strategic structural reform of financial and capital markets to stimulate private sector investments in growing sectors. The panel also said it was necessary to contribute to the economic development of other Asian countries by taking various measures including facilitating corporate funding in such countries.
Nearly eight years have passed, however, and Japan’s structural reform in the financial sector has proceeded at a snail’s pace — or at least not quick enough for the nation to become a leading international financial center by 2020, as envisaged by the panel’s recommendations.
Financial assets held by households hit a record ¥1.946 quadrillion as of the end of March thanks to a rise in stock prices and a decline in consumption as people stayed home amid the COVID-19 pandemic, according to Bank of Japan statistics released in June.
But even though household financial assets have increased in the last eight years, 54% of such assets — about ¥1.056 quadrillion — are still in cash and deposits, not in equities. Assets of Japan’s financial institutions are also largely held in the form of loans and government bonds, markedly higher than in Western nations.
Money in Japan, it appears, remains inactive.
Some of the measures to improve the investment environment have been put into practice to a certain extent, albeit slowly, such as the introduction of Nippon Individual Savings Accounts (NISA) to encourage small-size investment by individuals; governance reform of the Government Pension Investment Fund, the world’s largest pension fund; and the creation of the Japanese version of a stewardship code for institutional investors.
On the other hand, there were many cases in both the public and private sectors that indicate deep-rooted structural hurdles to improving the asset management ability of Japan’s investment management businesses.
For instance, efforts to enhance the asset management ability of Japan Post Bank Co. — one of the biggest banks in the world with total assets of ¥200 trillion — lost its steam half-way through.
After Japan Post Bank went public in 2015, the bank adopted a policy to strengthen its asset management, shifting away from JGBs to market equities, foreign bonds, hedge funds and alternative assets such as private equities.
The bank hired investment professionals by introducing an incentive structure meant to attract talented fund managers, and it appeared to have been taking a progressive approach as a Japanese financial institution.
However, more than half of the executives who led the reform, dubbed the “Seven Samurai,” have left the bank, including former Vice President Katsunori Sago who had been recruited from Goldman Sachs Group Inc. Sago joined SoftBank Group Corp. in 2018.
Since then, the bank’s risk-taking approach has diminished and it halved its initial target for expanding what it calls strategic investments, including alternative investments.
Moreover, the government-led efforts to supply risk money faced difficulties.
In Japan, firms have historically relied on indirect financing — mostly loans from banks — as a source of funds to operate. Such a financing environment, one that is not accustomed to equity investment seen in Western countries, is one of the causes of a low appetite to invest in equities as a society.
Therefore, the government came up with an idea of setting up public-private investment funds to encourage funding for next-generation businesses. As a result, more than 10 such funds were created one after another by different ministries and agencies, reflecting bureaucratic sectionalism.
The Japan Investment Corp. (JIC) was one such fund established in 2018 as a strategic entity to provide domestic risk capital to sectors related to the fourth industrial revolution characterized by a fusion of technologies.
But in late 2018, only three months after the fund’s launch, all nine board members, including President and CEO Masaaki Tanaka, resigned at once after a bitter standoff with the Economy, Trade and Industry Ministry over their executive compensation.
“The fund made a significant change from what we call a ‘public-private fund that utilizes best practices of the private sector’ to a ‘public fund that reflects the intentions of the government, the owner of nearly 100% of its shares,’” Tanaka said at a news conference to announce his resignation. “It became practically difficult for me to achieve the goals I aspired for the future of this nation.”
But there are countries which have succeeded in bringing vitality to their financial markets both strategically and with a long-term perspective.
The 1997 Asian financial crisis prompted Singapore to aim at becoming Asia’s financial center as a way to increase its industrial competitiveness since the late 1990s.
The Singaporean government clearly positioned the asset management business as a strategic industry and implemented a comprehensive package of measures including taxation, information technology infrastructure, recruiting human resources and offering training to improve their expertise.
Regarding state-held assets, Singapore changed the management policies of sovereign wealth funds, including Temasek Holdings Pte, initially an institution that held and managed the assets of state-affiliated firms, and GIC, which was established to manage the government’s foreign reserves.
To accumulate know-how and nurture industries in the strategic sector, the country allowed GIC to partner with private asset management firms and let Temasek invest actively overseas.
GIC’s overseas investment portfolio for the long term includes stocks, bonds, real estate and private equities, and it reported an annualized 20-year real rate of return of 4.3% in the year to March.
Temasek makes active investments in equities with a long-term horizon, taking advantage of growth in Asia including China and investing actively in promising startups in view of long-term trends such as digitalization and an increase in longevity.
In June last year, amid the COVID-19 pandemic, a group led by Temasek invested $250 million in German biotech venture firm BioNTech SE.
And in May this year, BioNTech announced that it will establish an mRNA vaccine manufacturing facility and its regional headquarters for Southeast Asia in Singapore, an apparent result of Singapore’s efforts to make use of its investments to achieve its economic strategies.
Temasek has been able to secure gains by selling shares when markets are recovering, generating total shareholder return in Singapore dollars of 7% over 10 years and 14% over the years since its establishment in 1974.
While the two — GIC and Temasek — are both government funds, their governance is said to be as accountable as that of private sector firms, having independent decision-making functions and implementing a high level of disclosure.
In the past two decades, the Singaporean government has managed to strategically turn the two firms into major global investors achieving high returns with assets exceeding the country’s gross domestic product.
Considering the history of public-private funds in Japan, it is doubtful whether the Singapore model, in which the government completely leads efforts to stimulate investments, would work in Japan.
However, there is no doubt that 20 years of implementing a comprehensive long-term strategy step by step with a clear vision in mind makes a difference.
What strategy should Japan work on for the coming decade?
The failures experienced by Japan Post Bank and JIC indicate the difficulty of establishing in Japan governance that best fits for making investments.
In order to create an asset management system that meets global standards, Japan must drastically change its employment practices, especially in the areas of designing incentives and making management decisions.
Asset management, for one, is a sector that requires a high level of expertise.
The world of professional fund managers pursuing economic rationality to seek excess returns is close to the world of top athletes.
To hire and nurture investment professionals who can beat powerful rivals around the world, it is indispensable to establish global-standard personnel and reward systems.
But this doesn’t only mean offering high paychecks to attract workers with expertise.
What is needed is a governance structure that supports professionals taking appropriate risks, allows swift day-to-day investment decision-making and at the same time ensures transparency and seeks strict accountability over its performance.
It would not be possible for an organization to achieve high returns unless its investment goals and policies, as well as responsibilities, are clear.
If workers of the organization think it is better to avoid taking risks and just hang on until retirement — a typical way of thinking under the lifetime employment structure — and if it takes a month for managers to decide on making investments, it will end up only with accumulating expenses of third-party investment management fees.
Moreover, if a large amount of funds are invested, it will certainly lead to losses in some cases in the short term.
Rather than reacting to short-term profits and losses such as quarterly figures, it is necessary to have the patience to evaluate investments in terms of whether they are bringing about appropriate returns, taking into account possible risks, as well as the objective and period of investment.
This will not be possible without a clear long-term strategy, an organizational governance framework to put the strategy into practice and the leadership with a strong determination to see it through.
In Japan, financial institutions continue to face an extremely difficult situation due to the shrinking domestic market and global low interest rates.
Institutional investors have to seriously think about how to improve their asset management abilities. Otherwise, the economy will only diminish, like a giant ship sinking slowly.
Both the public and private sectors should be committed to utilizing abundant inactive funds before the savings rate starts to diminish, so that increased flow of funds will contribute to achieving a vibrant economy and sustainable welfare.
Jun Mukoyama is a fellow at the Asia Pacific Initiative, an independent think tank based in Tokyo. API Geoeconomic Briefing is a series that looks into geopolitical and economic trends, with a particular focus on technology and innovation, global supply chains, international rule-making and climate change.
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