Betting the House?

Back to Contents of Issue: January 2000

Mutual funds go online in Japan (Part 1)
New risks and new returns for household investors and financial houses

by Aaron Cohen

Bring together all the factors, and the conclusion is as enticing as it is inevitable: There are now substantially greater prospects for non-Japanese financial sector companies to succeed in the Japanese market than ever before. The new twist to this is whether individual Japanese investorsÕ use of their personal computers and the Net will not only open that market up more, but open it to more companies as well.

The stakes are big. The amount of household savings in Japan is generally quoted as around ´1,300 trillion, or nearly $12 trillion at ´110 on the U.S. dollar. DonÕt bother to correct that for the outstanding household debt, because foreign institutions are glad to help the Japanese with credit as well.

Since I entered the Japanese securities industry in the 1970s, I have seen many companies come in, and some fade away. Others have stayed on, but few have had much impact or success. Now, however, it is a new sumo match, to mix a metaphor. It has become necessary to rewrite the book on Japan, adding many entirely new names, and the time to do so is right now. Despite a few warning signs along the way, some of the "old Japan hands" in the market are likely to do very well, and some bright-eyed newcomers run by Gen X entrepreneurs will be with them.

Pull factors abound
The powerful allure of the Japanese market to the old-timers and new arrivals alike derives from more than a few background factors, starting with the financial Big Bang deregulation barrage that knocked down some barriers to entry and diversified the instruments that can be offered in Japan. Then there has been the very slow but steady phasing-out of relationship banking (the "main bank" arrangement) and of venerable principles of stability such as cross-holding of shares and paranoiac avoidance of doing business with rival-group companies; scandals that reduced the credibility of major Japanese banks and brokers; and distress sales of failed institutions that make it possible to buy-in. These are familiar enough even from only the truncated headline news of cable TV. But inside the industry, you will hear of other factors. Superior business models, pointing toward much higher return on equity in banking, and financial technology in areas such as derivatives trading in the brokerage business are two of the advantages that bankers and brokers believe will help them take business away from Japanese competitors. Good product is invariably cited as a strong sales point. And right now, some are growing confident that the Net is going to help them to exploit those advantages.

The timing is important, particularly because of the confluence of two factors to add to all the rest: the start of Net trading and the creation of the still-unnamed equivalent of an American 401(k) personal pension scheme. The Net is the new method and (to a good extent) the mutual fund is the instrument that these companies believe will bring them success.

For practical purposes, Net trading started in Japan in 1999, and in 2000 some Japanese will start to manage a part of their own pension money. Several years will pass before Japanese Net trading emerges from infancy, and before a significant number of Japanese are in a position to act more like Americans and make their own decisions. But the companies that are intent on securing a profitable and lasting position in the market have to move, and are moving, now-even though for many, substantial profits are a few years on the other side of a very volatile period.

Go west young man
A lawless period, almost, as there is not yet a legislative or regulatory framework specifically for Net trading; the closest to that is the securities industry's own guidelines. (See excerpt in sidebar, p. 30.) And new entrants, revisions to the strategy deployed by the up-and-running firms, and major corporate realignments are all going to be taking place as the industry scrambles for position, prominence, and the money of investors.

If investors can be educated and helped to advance on their learning curves to achieve Net trading of equities and purchase of mutual funds, when the chance to manage some of their own pension money arrives, their appetite for mutual funds could increase at an accelerating pace. And selling funds on the Net offers important cost advantages for the firms chasing retail business.

Bellying up to the keyboard
Brokers offering online trading services now number more than 40, and industry sources expect perhaps 20 more. These, together with the companies that manage funds, as well as firms offering software technology or provider functions, are all back-to-back and belly-to-belly in the quest for the e-trading grail. It doesn't even matter if there is little solid market data in Japan; the U.S. precedent is enough to build business plans on. Estimates of market potential include 40-50 million Net users in three to four years (released by Monex, a Sony venture), and a bullish ´108 trillion in the mutual fund ("investment trust" in Japan) market in six years (according to Asahi Life).

The service package varies from firm to firm; some will handle margin trades, some will take trades from mobile phones or mobile terminals (Daiwa, Monex, Nikko, DLJdirect SFG, all using NTT DoCoMo's i-mode phones). E*Trade gives JAL mileage points according to the value of trades through their site. Tradable instruments vary, and certainly will expand. At press time, the major houses were not handling American stock trades, but the small Imagawa Misawa Securities, which specializes in online trading, does, and DLJdirect SFG Securities announced it would start to do so November 26. (Taking orders for American stocks has little real significance, however, as the sham of the Foreign Section on the Tokyo Stock Market shows. Individual Japanese investors may have little interest in buying foreign shares, even free of forex risk, and the industry's new online trading guidelines will encourage that negative trend.) Back-up telephone service and call center functions vary widely, as does information supply. So do hours of service, fees, and, lest we forget, commissions. Multilevel, real competition! This is not the old Japan.

Aaron "Marty" Cohen is chairman of the board of Capital Investment Advisory, a licensed asset management firm. He was chief financial economist in the Daiwa Securities group until retiring in 1998.

Who's who online?
Where do the "blue-eyed" brokers fit in? Well, what they fit into is kind of messy. DLJ-Donaldson, Lufkin and Jenrette, one of the major online brokers in the U.S.-has a joint venture with the group led by Sumitomo Bank, including both Sumitomo and Daiwa group companies. This bank is still in the throes of regrouping and integrating the Daiwa Securities companies. The poorly chosen name, DLJdirect SFG, will certainly be replaced with something else once Sumitomo and Daiwa figure out how to work together. Meanwhile, Daiwa and Nikko are engaged in thumb wrestling, each with their own left against their own right; Daiwa Securities competes with Daiwa Direct, a new subsidiary, and Nikko competes with the cutely named Nikko Beans, in which Goldman Sachs has a share of the equity. Both Daiwa Direct and Nikko Beans are online-only brokers. Wit Capital, known in the U.S. for its direct financing services, is in a ready-set-nearly-go situation, with a February start scheduled. The Paribas banking group, and Morgan Stanley Dean Witter, through Cortal and Discover Brokerage, respectively, are also joining the fray. The E*Trade-Softbank affiliation is well known, and Charles Schwab is expected to come in as a partner with Tokio Marine & Fire.

All together, at end-September last year, these companies had some 150,000 online accounts (growing daily), but no one will tell you how active or large those accounts are, so the six digits have little utility unless there is need for a random number that is a small fraction, which can be obtained by dividing it into the 8,500,000 accounts in the U.S. The rate of increase, however, is high, and there is fanatic belief that it will spiral further, almost infinitely, into the clouds. Daiwa, Nikko, and the now-defunct Yamaichi all had 30,000 accounts as the stated break-even point, but it is doubtful that their calculations had a solid base.

Bumps in the road

The major restraints (yes, there are restraints here) to growth are two: the behavior of individual investors in Japan, and government-approved, cartel-suggestive high costs for Net use. The other factors are either a function of market forces, such as the mixes of services and instruments offered, or technical, such as security and system reliability problems. As an illustration of how far the Japanese have yet to go, there are some who wring their hands over the danger that a person other than the investor will get access to the computer and play around. The worriers are, of course, descendents of the people who had nervous breakdowns when the bicycle was invented but had no bell.

The behavior issue is critical for the companies that plan to do mutual fund business here when the pension market opens up. Perhaps unduly, the Japanese were once stereotyped as economic animals, but they are hardly financial animals. In Buddhism, salvation can be by the strength of others (tariki) or that of oneself (jiriki); as far as pensions go, the Japanese have never relied on themselves and require much education and support before they will venture to invest a part of their own pensions on the basis of what is-or what they think is-their own decision.

Education thus has become a means of competition, and the brokers in particular are finding it easy to fill seminar rooms, while at the same time they are adding all manner of virtual classrooms, simulation games, and raw data to their websites. The working objective in doing this is to keep existing customers and perhaps attract new ones, for the entire range of instruments offered, but especially Japanese shares and mutual funds. Brokers and others, including Standard & Poor's, are trying hard to educate the industry and individuals about funds, but the fragmented, small-scale efforts are microscopic relative to the market and its potential.

Mutual funds will be among the favored instruments approved for inclusion in the equivalent of 401(k) accounts. This is one reason why all the city banks rushed to start offering funds to their customers when deregulation made this possible for them and other financial institutions in December 1998. They have not done very well, however, because of unfamiliarity with the product and its marketing. Companies from overseas have been selling funds to Japanese investors directly for a few years, after years of being forced into a subordinate role under the oligopolist brokers and broker-subsidiary investment trust firms. The cost and difficulty of building a retail base are major deterrents, and the brokers and banks have the brand and the customers, but also need products. Fidelity, no newcomer to Japan, will sell funds directly to Japanese, but has done well in large part by selling through Nomura. And Fidelity scored a strategic coup by arranging for 23 banks to sell its funds. Jardine Fleming sells through nine banks, brokers, and insurers. Companies like these two, with a wide range of funds, a good track record, and in-Japan experience, are likely to do well-at least to a point-by working through Japanese institutions.

Overseas companies interested in the busi- ness potential of the Japan market must jump in now, because even while the entire financial sector here is in a state of flux, business relationships with Japanese counterparts have to be made at this time so as to be fully functional when the market opens up and grows. The ultimate issue is, nevertheless, not whether a company is in the market here but whether it is earning a profit. And here there is some danger. The rush into the mutual fund business, propelled by various aspects of financial deregulation, is going to crowd the kitchen with individualistic chefs, to the extent that the guests at their tables will demand that prices (commissions) be slashed. The companies that survive will be those with the best partners or associates here, good brands and fund performance, and a long-term strategy backed by adequate financial resources. As far as potential sales and profits go, however, there are too many danger signals. The biggest danger threatening future profits will be the coming commission war. The biggest of all for market growth is the absence of investment risk consciousness among potential individual purchasers of mutual funds. Even while so much in Japan is changing, few Japanese dare to try to manage their futures. Many restaurants in Japan offer o-makase courses. In keeping with traditional thinking, namely that the server not the customer is king, this is a dinner that the house decides is best for those guests with no capability or interest in making a decision. It seems to be very Japanese after all.

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