Releasing the third arrow

Ratification of the Trans Pacific Partnership will present sustained opportunities for foreign asset managers to capitalize on a resurgent Japan.

Structural reform, the third arrow of Prime Minister Shinzo Abe's strategy to revitalize the Japanese economy, has yet to hit its mark, even as Japan's equities have rallied more in 2015 than at any time in the past 15 years. However, as the approval process of the Trans Pacific Partnership accelerates, asset managers should be ready for that third arrow to strike and set in motion a sustained transformation of the Japanese economy over the next decade.

Consisting of 12 Pacific Rim nations, the TPP is poised for comprehensive integration and will touch most areas of economic life by:

• lowering or eliminating tariffs on goods and services, opening long-closed industries to competition;
• liberalizing the service sectors;
• eliminating non-tariff barriers to trade within signatory nations;
• creating new export markets for signatory nations' products;
• increasing bilateral foreign direct investment; and
• paving the way for new rules on intellectual property rights among signatory nations.

The Peterson Institute predicts the TPP will lower agricultural tariffs and other internal barriers to competition, resulting in an 18% increase in Japan's exports. Trade privileges with the other 11 members of TPP will also attract foreign direct investment and translate to an estimated 2% increase of Japan's annual GDP.

Even without the ratification of TPP, entering the Japanese market has been a strategic objective for investors. The country's equity market has more than doubled since 2012, and the Nikkei and Topix have both risen by almost 15% in U.S. dollars year-to-date. Additionally, the reformation of the Government Pension Investment Fund and large-scale bond buying by the Bank of Japan have flooded the market with liquidity, estimated to reach almost $200 billion over the course of 2015. Likewise, corporate revenues and profit margins have both been improving, feeding into the systemic resurgence of the Japanese economy in the form of higher share prices, wage growth, job growth and increased exports.

Nomura Research Institute research shows a strong, upward growth in domestic retail and institutional investment, as well as a net increase in investment by overseas investors, in the past few years. All of these events have positive implications for a paradigm shift in corporate culture.

The cash flow from Japanese retail investors has experienced an upward trajectory for the last couple of years, reaching nearly $29 billion in 2014. Revenue and profit margin levels for retail investors also improved by 35% or almost $5.7 billion in 2014 and about $32.4 billion out of $120 billion of retirement benefits are predicted to be invested in Nippon individual savings account funds in the next five years.

Institutional investors' cash flow has also reached its highest level since 2008, with around $48.7 billion invested in equities. The rise in spending is due in large part to the GPIF's accelerated review process of domestic and international mixed assets. To achieve higher investment returns, this asset mix should include the following:

Japan's increased economic growth is poised to push inflation upward, wearing down the storing of household wealth in cash deposits and incentivizing investment in appreciable assets. Liquidity will also rise as capital flows into equities, further increasing the appeal of the Japanese market to foreign investors. Thus, TPP presents an opportunity for foreign asset managers to expand their clients' portfolios to include Japanese assets, as well as the chance to potentially expand their client base to include Japanese investors who will increasingly diversify wealth away from cash deposits. In both cases, asset managers must be aware of the unique guidelines for conducting business in the Japanese asset management market.

Foreign investors aiming to enter the Japanese market and foreign portfolio managers looking to capture the funds of Japanese retail investors abroad need to have tools that are calibrated to Japan's policies and regulations. Similarly, overseas investors should seek out comprehensive consulting as they navigate the country's market, including advice on how to incorporate Japanese assets into a portfolio, how to structure one's business model to comply with the country's regulations and how to address procedures for obtaining a license to operate domestically.

Kazumitsu Yokokawa is the head of financial services research and technology division at Nomura Research Institute America, Inc. and has more than 15 years of experience at the firm with the current focus on business development and client management in the U.S. financial industry.