The opportunity set for MLIM

Merrill Lynch Investment Managers sources over $40 billion from clients in Asia, Japan and Australia. Its Hong Kong-based regional managing director, Seiichi Fukuyama, discusses the firm's business priorities and the challenges of running a fund management business.

What does a snapshot of your business look like?

Fukuyama: Australia, Japan and the rest of Asia are three distinct businesses. We also have three joint ventures in Taiwan, Thailand and now China, all of which are minority shareholdings. In addition to this office, we also have offices in Singapore and Korea, and one in Taiwan which is separate from our JV. We have a joint venture in India but that now reports to London. Australia also reports directly to London, while Asia and Japan are managed by me, and I report to London, which runs our non-US business.

We've got 160 people in Japan and are probably the largest foreign fund manager of domestic pension money that's actively managed. We also have a mutual fund business there, and a full range of investment management teams, including large- and small-cap Japanese equities, Japanese fixed income, global fixed income and a quant team that manages long/short funds.

The presence in Asia is mainly sales and marketing, although we have some research, dealing and execution in Singapore. The Asian investment management team is part of the global emerging markets team in London. We have about 50 people in various offices in Asia, servicing both institutional clients as well as retail distributors.

You moved the Asian investment management function to London a few years ago. What impact did that have on your organization?

Nothing really. The focus of our business in Asia is to sell our global capabilities here. The product is manufactured outside of Asia. The issue was moving the fund managers from Singapore to London to put Asian equities managers closer to where decisions on global equities and emerging markets are made. There was a little cost cutting, but the emphasis was on efficiency, and putting the managers closer to global sector strategies and emerging market strategies. Also, emerging markets are often leveraged to what happens in America and elsewhere.

What has been your leading philosophy toward growing the business in Asia?

We grow organically. We don't try to go and buy something. Yes, we make some tactical investments here and there, but corporate culture is very important. If you bought a big entity, you'd dilute your own culture, unless you're big enough already in a particular country. We don't have the critical size to manage a large acquisition.

Why do joint ventures?

JVs are a very interesting animal. It's like a marriage. Sometimes you go out and seek a girlfriend, sometimes you meet a girlfriend by accident. Our JVs in Thailand and Taiwan both began in 1993. None of these were planned, we just happened to meet a wonderful girlfriend. It's the same in China; we weren't looking for a partner, but found one with whom our philosophies matched.

You have a JV in Taiwan, Shinkong Investment Trust, as well as a wholly owned unit.

Yes but they don't compete. We manage some of the JV's assets. Shinkong Investment Trust is a local vehicle launching NT-dollar mutual funds, whereas our own outfit focuses on the offshore market.

It's the same in Thailand, where we have a stake in K-Asset, the funds arm of Kasikorn Bank. It's a purely local business but Thailand is becoming more international, as are its pension funds, and individuals can now invest overseas.

K-Asset is the number-one mutual fund company in Thailand and Shinkong is something like number four or five in Taiwan, and we hope it will be number one soon.

The latest JV is China.

Our stance was to do nothing until we could be in a wholly owned situation. But here came Bank of China, which explained its vision. We liked each other and we said, OK, let's help each other.

It was a good opportunity, yet you gave up on having a wholly owned business.
Because we don't know. If someone can tell me, "Just wait three more years," then... but we don't know. And now we're committed to the JV. When you get married, you don't talk about divorcing, you talk about how wonderful life will be together.

Do you want to get a 49% stake in the China JV?
We own 16.5%. All of our JVs around the region are about that level, so we don't question it. It's worked well in Taiwan and Thailand. The name that's known in China is Bank of China. I don't see the point of going to 49%. A minority stake is a minority stake. The question is when could we be the majority owner? We don't know.

Which offers a bigger growth opportunity, your regional institutional business, or the retail business?

Our institutional business is a very stable, cash flow business. The real growth will continue to come from mutual funds. We're still under-resourced and we continue to place people in the region, in each country.

Which retail markets offer the most growth?
Taiwan and Korea are quite exciting. We distribute through the Merrill Lynch Private Bank but third-party distribution is becoming bigger. We don't seek active partnership with local distributors. Some fund houses go into a market and sign up with everybody. We're more conservative. We prefer to deal with just a few people, and understand each other more deeply. Just like in a JV, we have to like each other.

What are the issues for your institutional clients?

We go for the top 20 institutions across the region. The big guys tend to focus more on fixed income, and they've been more willing to take more credit risk and move to aggregate fixed income-type of products. They're more willing to look at alternative investments. There's two schools of thought, some did invest in hedge funds, others haven't. But the knowledge base for alternatives is growing. There's still scepticism, because sometimes hedge funds work, sometimes they don't. But the hedge fund market is good, and it's putting a new focus on how traditional managers also generate alpha.

The other trend I see is that there's still room to play for passive and enhanced indexing strategies. The passive guys like BGI and State Street are doing well. We also have a passive team, and there are more opportunities for us to sell. At the global level, because the market is cornered by BGI and State Street, we're now getting a share of the pie, because pension funds think it's important to diversify their manager base. It's still early days in Asia so the other names are growing faster, but I think we have a distinct investment style that will be picked up here.

How do you bolster your operation in Korea? Are you looking at a JV there?

We've been there since 1995 as a rep office, and we've remained a rep office, so our scope of doing business is limited. But Korea is the largest economy in Asia after Japan, Koreans have really started to appreciate the benefits of international diversification, and there's been a period where the quality of local fund management companies is questioned. The question is, how do we go from being a rep office to the next step? We've been talking about this for the past 12 months or more. In fact we were talking about this in the 1990s but got interrupted by the Asian financial crisis and then three years of bear markets. We're now revisiting this, but nothing concrete can be mentioned. We need to recruit more talented Koreans, both domestically and internationally, to support the business. It's a gradual build.

What's the biggest challenge for your organization?

People. We have many people who have been with us for a long time, and the challenge is whether they will stay. Succession issues are not easy.

Is the prospect of starting a hedge fund luring your people away?

We've lost some fund managers in Japan who wanted to set up their own hedge funds. It's sad but all we can do is revisit our compensation structure. We're rolling out the concept of being a boutique with institutional backing, to ensure our teams manage funds like at a boutique house but with the franchise's support.

I visit a lot of hedge fund managers and I ask them what they miss. Many say they miss having the infrastructure supported by a large corporation. Now they have to do everything themselves. Also, the compliance work is tougher. The next thing Eliot Spitzer [New York's attorney general] will look at is hedge funds, and that will have a global impact. The cost of doing business used to be cheap but I'm not sure all of these small companies can survive.

In Japan, there are 130 registered investment companies with discretionary investment licenses. The top 30 make up 85% of the total industry revenue. Some smaller shops make money, but clearly the large boys like us are here to stay. Small companies are a credit risk. What if a boutique house goes bankrupt? Risk management is so important. We manage $40 billion in Asia Pacific. If there's a mess up in dealing or a breach of guidelines, the money needed to compensate a client could wipe out two or three years of revenue. We're OK because we're big, but what about a small company operating a relatively large amount of money? This sort of issue will start to come up.