Japan’s fund reform to put fee pressure on local players
Japan’s fund industry is set to see a marked inflow of investor assets into passive funds, plus a potential shake-up in the business models of its major players, when a new low fee fund vehicle is introduced next year.
The new fund structure, called the Tsumitate Nippon Individual Savings Account (Nisa), will be launched in January. The low cost, installment-type saving product is the first step in the Financial Services Agency (FSA)’s attempt to to lure money out of retail bank accounts by forcing local fund players to change their habits of selling funds for high fees and then churning them for more profit.
Nisa is a tax-incentivised scheme suited for individuals which, while not involuntary like Hong Kong’s Mandatory Provident Fund Scheme, is expected to become a mainstay for regular savers. It will let individuals invest as much as ¥400,000 ($3,600) a year into domestic or foreign stock or bond funds for up to 20 years without having to pay taxes on capital gains or income.
Industry observers spoken to by AsianInvestor say the launch of Nisa aligns with the Abe government's desire to mobilise the estimated $8.8 trillion of Japanese private wealth currently held in low-yielding bank deposits. Additionally, the new funds will force wholesale changes to product development and financial advice in Asia’s biggest fund market. This is very much part of the plan of Nobuchika Mori, the FSA’s reform-minded commissioner.
Funds in Japan today are so expensive that investors have little inclination to invest heavily into them.The FSA calculates that the average sales commission fee for the top 10 funds in Japan is 3.1%, while the average management fee is 1.5%. In other words, the average top 10 funds needs to return more than 4.6% a year in order for investors to avoid losing money.
In contrast, the maximum amount of combined management and sales fees being charged by Nisa-approved funds stands at 0.75%.
Nobody is sure how much business will result from the new structure, or whether it is sustainable with fees so low. However, based upon the experience of other countries it’s likely there will be a strong audience for the low cost products, particularly exchange traded funds.
The introduction of passive funds in other developed countries, and particularly the US, was followed by a huge inflow of assets into passive index funds and ETFs. Since 2003, when the first ETF was launched in the US, the market has growrn to $3 trillion.
Japan, in contrast, only has $200 billion invested into ETFs according to Nomura Securities —and 70% of that is investment by the Bank of Japan as part of its quantitative easing efforts. However, this is likely to change.
Jesper Koll, chief executive for Japan of ETF specialist Wisdom Tree, predicted that, based on experience from the US, it could be a boon for the local ETF industry. “If you had a similar type of structure, you would find probably 60% to 70% of the (new) money invested in ETFs. That's another $50 billion that could potentially flow into the local ETF marke,” he told AsianInvestor.
Withering criticism
The introduction of Nisa is part of a larger effort by the FSA to break the bad business habits of its local fund industry.
Speaking at a Securities Analysts Association of Japan conference in April, Mori accused fund groups of “seeking their own benefits, with little regard for customers’ interests”.
He noted their greed has stymied growth in fund assets. “The growth in financial assets owned by households over the past 20 years that is attributable to investment returns is 19%, a far cry from the growth of 132% in the US,” Mori told the conference.
“Does a business model like this deserve to be preserved in our society?”
One reason this has happened is that Japan’s fund industry is effectively an oligopoly. Mori observed that over 80% of all funds have been established and are managed by fund managers affiliated with one of the major banks or securities houses.
“That leads me to suspect that these affiliated companies are creating products which are convenient for sellers to rake in sales commission fees,” he said.
Koll approves of the shift, saying it is likely to have major consequences for the industry.
“When you break the fees down, this is the dirty secret in Japan,” he told AsianInvestor. "The really bad news in this initiative is for the distributors. There isn’t an asset manager in Japan right now who isn’t under the gun, in terms of rethinking their business. The regulatory stick has come out in a way the Japanese had not expected.”
Need for change
To come up with Nisa, the FSA established a working group tasked with identifying funds that are fit for investment through the Nisa programme. Out of 5,400 publicly available funds, it initially chose just 50 in June, filtering any funds that charged a sales commission or management fees in excess of 0.75%.
Domestic fund groups such Nomura, Daiwa, Sumitomo Mitsui and Nikko Asset Management are now busily developing new low-cost and largely passive funds in preparation for the January introduction of Nisa. As a result, the range of permissible funds has now been extended to more than 120.
Ian Fontaine, marketing manager with Nikko Asset Management in Tokyo, told AsianInvestor his firm has several products approved within the Nisa programme, including one of only 13 active funds approved by the FSA for the initial launch.
Forcing better service
The wider agenda for the Abe government is to create a more professional financial sector in Japan.
Koll said there is a perceived lack of sophistication in general among asset management professionals. “There’s a realisation that Japan does not have a world class financial services business.”
The funds veteran sits on a committee to revitalise Tokyo as a financial centre. He noted that while many Japanese companies aspire to be the best in class in the world, “when you talk to people in the financial services industry in Japan, they never have that ambition. It’s not viewed as a serious discipline”.
Mori acknowledges this too, saying “When it comes to the competitiveness of the financial industry, Japanese asset management companies have no presence on the global stage”.
While the primary goal of the government and FSA appears to be to shift household assets from banks into Japan’s capital markets, making its fund houses become better players would be a major ancillary benefit.