Relative to the expansion seen in Western markets, the Japanese ETF market has remained stagnant during 2009. So what is happening in Japan, asks Koei Imai, of Nikko Asset Management.
It is important to take a look at how ETFs started out in Japan to understand the current situation. The first ETFs came about partly as a means for Japanese financial institutions to unwind their cross shareholdings. Instead of holding shares in other Japanese companies, they diversified their portfolios by holding ETFs instead. As a result, historically the main investors in ETFs have been financial institutions, such as banks and insurance companies, who mainly preferred ETFs that tracked the Japanese equity market.
The Japanese government has introduced new policy measures to help facilitate the launch of new ETF products which take exposure in a diverse range of asset classes. In December 2007, they announced a plan – ‘Strengthening the Competitiveness of Japan’s Financial and Capital Markets’ – which aimed to open up markets to non-traditional ETFs. Their efforts were successful and the number of ETFs listed on Japanese stock exchanges increased from just 18 in December 2007 to 107 as at September 2010. However despite such government efforts, asset growth has been sluggish, with the majority of investors still preferring traditional Japan equity ETFs.
One of the factors generally used in assessing current demand for ETFs is investor demographics. For example, the breakdown of investors in Nikko AM’s Topix and Nikkei 225 ETFs is roughly 70% Japanese banks and insurance companies, with the rest equally divided up between brokerage houses (which act as authorised participants), retail and overseas investors.
We believe financial institutions became sellers of ETF holdings during 2009, as it became more difficult (especially for large financial institutions) to invest in assets which are market sensitive and subject to price fluctuations, given the stricter capital requirements set forth under Basel II. As a result, many banks and insurance companies began to sell and this trend is expected to continue.
Interestingly, ETF assets increased during the month of September 2010. Our view is that Basel II has also impacted Japanese corporations, leading them to unwind their cross shareholdings into ETFs. However, these investors may eventually redeem their primary shares directly from the ETF unless there is demand for secondary share trading in the markets. It remains to be seen whether the unwinding will ultimately help spur growth.
Seeds of growth
So what are the catalysts for ETF growth in Japan?
The recent announcement by the Bank of Japan (BOJ) to set up a ¥5trn (€43bn) fund to buy a wide range of assets, including Japanese ETFs, is expected to provide a catalyst. We expect the BOJ to be long-term investors, holding ETF shares, rather than trading in secondary markets, which will help asset growth. Additionally, this action by the BOJ will have a positive impact on the perception of ETFs by Japanese investors, prompting them to consider them for their own portfolios.
We also believe that diversification of the investor base will be critical in facilitating further growth. For example, small- to mid-sized financial institutions are less impacted by Basel II. They actively manage their cash portfolios and could diversify market exposure by using ETFs. The advantage of this (rather than mutual funds), is that any dividends paid out can be treated as profit from (an accounting perspective), which is an important part of income.
Some retail investors have also found ETFs to be an attractive prospect, due to the lower fee structures (again, relative to mutual funds) and ease of use. However, similar to the situation in Europe, this tends to be just a small group of well-educated investors, who actively manage their own portfolios. Retail investors currently hold approximately ¥1,400trn in total financial assets. While the Japanese traditionally tended to hold assets in the form of savings, there is increasing recognition that pension payouts and savings will not continue to grow at historic rates. Many more individuals are therefore waking up to the need for investment. Furthermore, some of the large brokerage houses are also now actively looking to sell ETF products to retail investors, which was an area previously ignored, due to the low fee structure.
Overseas investors are already a large segment of the Japanese market, representing 30-40% of the total transaction volume on the Tokyo Stock Exchange. However, when it comes to ETFs, language may be a main barrier to entry for most overseas investors – Japanese ETF providers have focused their efforts on marketing products to Japanese investors and information has only been made available in Japanese. Providing it in English may be a simple first step.
Our general view is that in the end, good investment products will gain in popularity. Relative to the US and European markets, we believe that the Japanese ETF market has been slow to grow due to lack of investor awareness. Although we are unable to predict the timing of when the Japanese ETF market will take off, we strongly believe that it will. We also believe that education will be key for all investor segments, in encouraging the use of ETFs.
• Koei Imai is head of the ETF centre at Nikko Asset Management
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