TOKYO - Deregulation of Japan's corporate pension industry has begun to snowball, bringing both challenges and opportunities to pension sponsors and firms that wish to service them.
Japan's larger Employees' Pension Funds already experienced a number of liberalizations aimed at helping them meet the obligations inherent in a rapidly aging society. (EPFs substitute for some benefits normally provided by the government and supply additional benefits.) The next steps, coming with the April 1 start of Japan's fiscal year, will propel pension deregulation into new areas, including Japan's Tax Qualified plans.
Among the changes:
EPFs will switch to market value accounting from book value.
Tax Qualified corporate funds, typically smaller funds not involved with the basic national pension, are expected to be granted freedom from the 5-3-3-2 investment rule.
As of April 1, EPFs will be allowed to include money invested in general accounts handled by insurers as part of the overall 50% or more that must be held in principal-protected "safe" assets. For some funds, this might provide an opportunity to increase holdings other than fixed income.
In April, the prescribed 5.5% assumed return for actuarial calculations will be relaxed. Existing EPFs will then begin an actuarial evaluation process to help them determine what their own assumption rate should be. According to schedule, most EPFs will be able to implement their new actuarial assumption in April 1999.
These moves come on the heels of increased EPF deregulation last year. In 1996, Japan's 1,846 EPF funds no longer had to apply the 5-3-3-2 rule to each portfolio managed by trust banks but instead could apply it to the fund's overall investments.
(The 5-3-3-2 rule requires a minimum of 50% of assets be put in "safe" investments, while no more than 30% can be in domestic equities, 30% in foreign securities and 20% in real estate.)
In addition, investment advisers were given access to as much as half of EPFs' assets, up from one-third. Last year, Japan's Ministry of Health & Welfare also began to allow complete investment freedom to some sophisticated EPFs.
At the end of 1996, the 5-3-3-2 rule had been completely scrapped for nine EPFs: the Pension Fund Association, Japanese Securities Companies Association, Japanese National Surveyors' Pension Fund and the funds of Hitachi Ltd., Mitsubishi Electric Corp., Toyota Motor Corp., Meiji Nyugyo, Fujitsui and Fuji Electric Co.
In the meantime, Japan's 91,465 Tax Qualified Pension Plans are poised to gain freedom from the 5-3-3-2 rule. That comes as part of recommended changes that tie in with Japan's "big bang" package of financial reforms that have already been set in motion. Late last year, the governmental Administrative Reform Committee made recommendations for financial reform that included a number of TQPP-related measures.
Although scrapping 5-3-3-2 for TQPPs is to take effect in April, other changes evidently won't be implemented. For example, TQPPs still will not be able to use investment advisers until at least later this year. This could slow TQPPs' taking advantage of deregulation.
Some observers attribute the delay to concerns by the Finance Ministry about letting investment advisers into an arena controlled by insurance companies and trust banks - especially given the financial woes besetting Japan's banking sector. Theoretically, competition could be tough on insurers and trust banks, given their history of managing with a balanced approach and their orientation toward meeting the prescribed 5.5% return rather than a market-oriented benchmark.
However, Kenichi Nagami, the minister's secretariat and coordinator for tax qualified pension plans, offered another explanation. He stressed legal changes permitting use of investment advisers should be in place by April 1. But additional safeguards for fund assets and structures for accommodating investment advisers in the overall system also are needed. Once these arrangements have been made, TQPPs will get the green light to use investment advisers, he said.
Over time, funds are expected to take advantage of deregulation to boost overall returns (see accompanying story).
And equities should be a beneficiary, as data from Goldman Sachs (Japan) Ltd., Tokyo, show. While exposures to non-Japanese equities averaged 8% in 1996, the figure should jump to 20% to 30% in 2001, according to Goldman Sachs. Holdings of Japanese stocks should increase to an average 30% to 40% in 2001, compared with 25% in 1996.
In comparison, average estimated holdings in life insurers' minimum return guaranteed products should drop to 10% to 15% from 25% last year; domestic bonds should drop to 25% to 30% from 40% in 1996, and foreign bonds should inch up to 5% to 10% from 2% in 1996, Goldman's data show.
Whether funds will want to move quickly into equities, especially domestic equities, remains a question. To Yukihiro Asano, head office executive with the Sumitomo Trust & Banking Co. Ltd., Tokyo, investors would be making a mistake to invest more heavily in equities. In his opinion, Japan's market conceivably could be in bad shape "until the 21st century."
But another camp sees market improvements ahead. To some of them, current stock prices may even be a buying opportunity.
Outlining his firm's bullish scenario, Masafumi Hikima, general manager and chief portfolio manager, investment strategy and management group, Nikko International Capital Management Co. Ltd., Tokyo, said his firm projects a 15% average annual return in Japan's market over the next five years. Toward the end of 1997, Mr. Hikima expects the Nikkei 225 stock index to be 22,500 to 23,000, compared with 19,034.54 Feb. 21.
But whatever the market's situation, it's clear investment managers see opportunities and challenges amid the raft of changes. Players in all three main areas - trust banks, insurance companies and investment advisory firms - have been gearing up to address the new environment. And one likely winner should be the investment advisory sector.
According to forecasts by Goldman Sachs, admittedly not an unbiased observer, investment advisers are set to reap hefty business gains. Their share of total Japanese pension assets should leap to 30% to 40% in 2001 from 7% in 1996. Conversely, Goldman's data has trust banks' slice dropping to 40% to 50% in 2001 from 60% in 1996 and life insurers' share falling to 20% to 30% in 2001 from 33% in 1996.
Last year, a number of EPFs, as well as the enormous Pension Welfare Service Corp., sharply lowered their holdings in insurance general accounts after their guaranteed return was sliced to 2.5% from 4.5%.
Trust banks have their own shortcomings, some competitors feel. "They are not seen as strong in portfolio management since they always have been run as balanced portfolios without a clear market benchmark," said Donald J. Mulvihill, president, Goldman Sachs Asset Management Japan Ltd., Tokyo. In addition, "their trading expertise is in Tokyo, and they have not been managing assets from international offices. Thus they don't have the global capability of foreign investment advisory firms such as Goldman's."
"For EPFs, we provide advice on active management, including asset allocation. Trust banks and insurance companies have grown up in a 5-3-3-2 environment and are not as able to provide such advice," he maintained.
But trust banks and insurers are hardly withering in the face of new competition. Acknowledging the changing landscape, savvy players are seeking their own ways to capitalize. This can include everything from intensifying their service to clients to expanding their product lines and overall range of operations.
To Sumitomo's Mr. Asano, "trust banks can deal with anything - asset allocation, stocks, bonds. If we have an advantage, it's in asset allocation with some consideration to a fund's liabilities." In fact, if pension "liabilities are deregulated (the 5.5% assumption is relaxed) trust banks would be even stronger (competitors) in that trust banks could do more in asset/liability management and more about asset allocation with some consideration to liabilities."
As a foreign-based trust bank, Japan Bankers Trust Co. Ltd., Tokyo, includes among its strengths its global investment capabilities and its capabilities to create separate accounts in various stock specialties such as U.S., Asian or European accounts. While almost all assets are in balanced accounts, officials say the firm's foreign equities exposure surpasses that of its Japanese-based trust bank competitors. That factor might be contributing to Japan Bankers Trust's performance, which Chief Investment Officer Kunihiko Nakao said is "always in the first quartile of balanced accounts that follow the 5-3-3-2 rule." As of January, in balanced accounts the bank had 22% in foreign equities, compared with 7% to 8% by Japanese-based trust banks, he said.
Assets under management have expanded for Dai-ichi Seimei Capital Management Co. Ltd., Tokyo, the investment advisory arm of Dai-ichi Mutual Life Insurance Co. As of January, assets under management stood at Yen 250 billion (U.S. $2.08 billion), or about three times higher than the year before. That growth came largely because of a shift from general accounts, said Ryujiro Miki, general manager, investment planning department, Dai-ichi Seimei Capital.
But Mr. Miki believes "the most dramatic outflow from general accounts will end soon." He believes general accounts, with their guaranteed return, could evolve as the "anchor" for pension funds, helping smooth returns.
However, Dai-ichi Seimei Capital also is facing hot competition. As a result, the firm is sharpening its skills: fine-tuning its investment model, beefing up its international capability by hiring an investment manager with U.S. market expertise and looking to win clients outside of Japan.
"So far the Japanese investment advisers have been fighting for market share within Japan. But from now on, the successful (investment advisers) will have foreign clients," he said.
Not only is the domestic marketplace limited, but it's "prestigious to have foreign clients, said Mr. Miki. "It helps with domestic marketing."