Center on Japanese Economy and Business Japanese Government...Center on Japanese Economy and Business Japanese translation inside Opening Remarks Alicia Ogawa, Senior Advisor,

Center on Japanese Economy and BusinessPROGRAM ON ALTERNATIVE INVESTMENTS

The Japanese Government as a PortfolioManager: Managing the Nation’s Wealth October 21, 2008

Symposium Summary ReportJeffrey Lagomarsino, EditorSenior Research and Editorial OfficerCenter on Japanese Economy and Business Japanese translation inside

Opening RemarksAlicia Ogawa, Senior Advisor, Center on JapaneseEconomy and Business, Columbia Business School

Opening Keynote SpeakerTakahiro Kawase, President, Government PensionInvestment Fund (GPIF)

Session I ModeratorRobert Alan Feldman, Director of Economic ResearchDepartment, Morgan Stanley Japan, Ltd.

PanelistsMasaharu Sakata, Director of Private Equity InvestmentGroup, Pension Investment Department, Pension FundAssociation

Taisuke Sasanuma, Representative Partner, AdvantagePartners, LLP

Cheng Chih Sung, Managing Director and Chief RiskOfficer, Government of Singapore Investment Corporation

Yo Takeuchi, Chief Financial Officer, Development Bank ofJapan Inc.

Session II ModeratorAlicia Ogawa

PanelistsJohn Ehara, Chief Executive Officer, Unison Capital, Inc.

Takeshi Isayama, Chairman, Carlyle Japan

Takatoshi Ito, Professor, Graduate School of Economics,The University of Tokyo

Takehiko Nakao, Senior Deputy Director-General ofInternational Bureau, Ministry of Finance, Japan

Session III ModeratorHugh Patrick, Director, Center on Japanese Economy and Business, Columbia Business School

PanelistsJunichiro Sano, Chief Executive Officer, Dalton Investments KK

Clifford Shaw, Advisor, Program on AlternativeInvestments, Center on Japanese Economy and Business,Columbia Business School

Mamoru Taniya, Chief Executive Officer, Asuka AssetManagement, Ltd.

Bill Wilder, President and Chief Investment Officer, Nikko Asset Management Co., Ltd.

Closing Keynote SpeakerRobert Kaproth, U.S. Financial Attaché; Representative,U.S. Department of the Treasury in Japan

2 The Japanese Government as a Portfolio Manager: Managing the Nation’s Wealth

The Japanese Government as a Portfolio Manager: Managing the Nation’s Wealth October 21, 2008

The Program on Alternative Investments of the Center onJapanese Economy and Business (CJEB) at Columbia

Business School hosted a conference in Tokyo, Japan, titled“The Japanese Government as a Portfolio Manager: Managingthe Nation’s Wealth.” One hundred sixty-seven people attendedthe conference to hear the views of seventeen distinguishedspeakers on the topic of a Japanese sovereign wealth fund(SWF). This report summarizes the presentations of the con-ference.

Opening RemarksAlicia Ogawa, director of the Program on Alternative Invest-ments (senior advisor to CJEB as of January 31, 2009) andadjunct associate professor at Columbia University’s Schoolof International and Public Affairs, opened the conference bynoting that although concerns over the power and behavior ofSWFs have diminished amidst the global financial crisis andeconomic slowdown, it was nonetheless an important timeto discuss the political and economic issues they present.Professor Ogawa identified several key questions: What is thebest way to engage SWFs? What role should they play in therecapitalization of financial institutions? What incentives shouldbe introduced to guide their behavior? She noted that the recentInternational Monetary Fund (IMF)–sponsored discussionsamong SWFs have produced a list of “best practices,” termedthe Santiago Principles, which have advanced the debate byproviding a normative road map that SWFs intend to follow.

Professor Ogawa explained that the intent of the confer-ence was to examine a variety of issues underlying the debateon sovereign wealth funds in Japan. The current debate in Japanas to whether or not to establish its own SWF is a diversionfrom a far more basic and important topic: What are the coun-try’s goals in managing its wealth, and who should beaccountable for the end result? Professor Ogawa said thatwhether or not one chooses to classify the Government PensionInvestment Fund (GPIF) and the foreign exchange reservesmanaged by the Ministry of Finance as de facto SWFs, theintroduction of new styles of investment and corporate gover-nance in these funds are very important and controversial issuesfacing Japan. While the present market volatility makes it tempt-ing to justify traditional approaches to managing the nation’swealth, such traditional approaches are no substitute for activerisk management. Professor Ogawa emphasized that a broaderdebate over SWFs in Japan is vital because it fosters pro-ductive examination of other major, long-standing policy issuesbeyond the management of GPIF and the foreign exchangereserves. Among these issues is Japan’s stance on foreign SWF

investment, which will require policy makers to reexaminethe government’s ambiguous attitude toward private foreigndirect investment (FDI). Furthermore, Japan must consider whythe government rather than the private sector is tasked withmanaging the nation’s wealth, and implicit in this discussion isthe important question of what can be done to create a dynamicprivate fund management industry in Japan.

Opening Keynote Speech: Investment of Public PensionReserve: Objectives and StrategyTakahiro Kawase, president of GPIF, began his keynote speechby addressing the relationship between GPIF’s investmentmandate and the broader design of the pension system. Hesaid there is a common misconception that GPIF can set a tar-get rate of return on investment independent of the government’sconsiderations. In fact, GPIF’s target rate of return is deter-mined largely based on the levels of pension premiums andbenefits set by the Ministry of Health, Labor and Welfare, aswell as demographic and economic forecasts.

Mr. Kawase went on to acknowledge that stresses on pub-lic pension finances, such as caused by Japan’s rapidly agingpopulation, create a natural inclination for governments to seekhigher investment returns with the hope of raising revenuewithout burdening the public with higher premiums or bene-fit cuts. Many governments have begun to pursue this strategy,which entails a portfolio shift to greater equity holdings. However,Mr. Kawase stressed that pursuit of higher yields throughincreased equity investment requires higher risk tolerance andincreases the exposure of the pension system to the finan-cial markets. In the case of lost investment revenue duringan extended financial downturn, the government must ulti-mately be willing to shift the financial burden back on the public.He explained that GPIF is constrained with respect to theamount of risk it can assume, because the Japanese public hasa low risk tolerance and the government has promised to capcontribution rates at 18.3 percent and has also set a minimumlevel of benefits at 50 percent of the present generation’s aver-age income.

Accordingly, Mr. Kawase said GPIF follows a passive port-folio strategy in which its asset composition is positioned forthe long term and is reviewed every five years. This is in con-trast to a more activist tactical asset allocation strategy followedby many pension funds, which adjusts the portfolio’s asset mixto take advantage of short-term market trends. Comparedto private pension funds and many foreign public pension funds,GPIF holds a high ratio of domestic bonds and seeks betareturns. This conservative approach is a major criticism of

Center on Japanese Economy and Business October 21, 2008 3

GPIF’s portfolio strategy, given that it has generally beenoutperformed over the past five years by pension funds withhigher equity ratios. However, Mr. Kawase defended GPIF’sstrategy by noting that—at the time of his presentation—themost recent performance figures were from March 2008, andgiven the dramatic decline of stock prices over the last severalmonths, GPIF has been spared the major losses that other pen-sion funds are suffering.

Mr. Kawase next addressed the fact that GPIF’s basic port-folio strategy has precluded alternative investments, and heexplained the considerations being given to diversifying intoalternative asset holdings. First, he noted that the true risk-return tradeoff for alternative assets is unknown because thereis only short-term data, which does not offer a track recordof performance through cycles of various economic and finan-cial conditions. He said that while the available data looksimpressive, it will be very interesting to reevaluate alternativeasset performance subsequent to the recent market upheaval.Second, the risk-return tradeoff for alternative investments isvery much dependent on the manager’s skill, which he saidmakes alternative assets difficult to position within a basicportfolio strategy. Furthermore, the resources required toselect, supervise, and compensate such a manager must alsobe considered. Finally, GPIF must determine what degree ofdiversification into alternative investments is meaningful, andthen assess whether that is realistic given the size of GPIF rel-ative to the alternative asset markets.

In conclusion, Mr. Kawase argued that characteristics oftypical SWF investment are not compatible with GPIF’s objec-tive based on the current design of the public pension system.He said that the source of many SWFs comes from the saleof domestic natural resources and that they are managedaccording to national interests, such as securing access toenergy sources or fostering global financial stability by recap-italizing Western financial institutions. A nation’s people arewilling to accept higher risks and greater losses in cases whereinvestments are made to strategically promote national inter-ests, he said. Conversely, he emphasized that most Japaneseare very conservative with their personal wealth and that theywould not tolerate the public pension fund being invested ina risky manner. While some argue that allocating a portion ofGPIF to be invested more aggressively could be done in a man-ner that helps foster a more dynamic fund management industryin Japan, Mr. Kawase questioned the necessity and efficacyof such a scheme.

Session I: Does Japan Need an SWF? Issues and ObservationsMasaharu Sakata, director of the Private Equity InvestmentGroup, Pension Investment Department, Pension FundAssociation (PFA), discussed the PFA’s investment strategyas well as some of the potential benefits of a Japanese SWF.The PFA, which is comprised of the private pensions of earlyretirees from Japanese companies, is Japan’s largest private-

sector pension fund manager and has grown significantly overthe past fifteen years, as many have left the public pensionsystem because of the weak Japanese economy. The PFA man-ages over 12 trillion yen, the great majority of which is investedin Japanese and foreign bonds and equities. Faced with anaging population that requires higher payouts, Mr. Sakata saidthe PFA is seeking higher returns and recently began invest-ing in alternative asset classes. A team has been establishedat PFA to manage private equity, hedge fund, and real estateinvestments, and the PFA aims to increase investment in eachof these asset classes to 2 to 3 percent of total funds undermanagement. Mr. Sakata echoed Mr. Kawase’s concern overthe importance of risk management for pension funds, buthe suggested that this was possible while still increasing alter-native asset holdings.

Mr. Sakata said that Japan should create an SWF to man-age some of its foreign exchange reserves and other verylong-term assets. While he conceded that investment objec-tives and strategies are dependent on the nature of the fund,he said that an SWF could still be used to cope with the demo-graphic challenges to Japan’s pension funds, as well as to investstrategically to promote national interests.

Taisuke Sasanuma, representative partner of AdvantagePartners, LLP, shared his personal views based on his experi-ence at a private equity fund and his interactions with SWFmanagers. He said a Japanese SWF should be created with10 trillion yen, derived from parts of Japan’s foreign cur-rency reserves and GPIF assets. Based on Japan’s GDP, heestimated 30 trillion yen would be a reasonable size for aJapanese SWF to ultimately reach. In terms of SWF man-agement, Mr. Sasanuma emphasized that the fund shouldbe operated fully independently of the Japanese governmentand according to a performance-based compensation system.Further, he suggested a globally diversified asset allocation,with an emphasis on alternative investments, particularlyprivate equity, given theirattractive risk-return profiles relative toother asset classes, as demonstrated over the past ten years.

Mr. Sasanuma argued that the next stage of developmentof the Japanese economy must be based on intellectual prop-erty rights and a strong, globalized financial services industry.While Japan is a leader in technology and intellectual propertyrights, much must be done to develop the financial servicesindustry and establish Tokyo as an Asian financial center. InMr. Sasanuma’s opinion, this requires training a new genera-tion of fund managers and fostering institutional know-how,to both of which a Japanese SWF could contribute significantly.He concluded with the observation that the current financialcrisis has created many opportunities to buy cheap equities, andJapan should establish an SWF expeditiously to take advantage.

Cheng Chih Sung, managing director and chief risk officerof the Government of Singapore Investment Corporation (GIC),described the company’s mission, organization, and invest-


ment strategy, as well as the lessons to be learned from theirtwenty-seven years of experience investing sovereign wealth.The GIC was established as a private company wholly ownedby the government of Singapore, however the relationship isthat of fund manager and client. Mr. Sung explained that theGIC is charged with managing the nation’s reserves to achievea target real return above global inflation within specific risktolerances. Three GIC subsidiaries carry out the investmentmanagement functions—the largest, GIC Asset ManagementPte Ltd, handles public market investments, and two smallersubsidiaries, GIC Real Estate Pte Ltd and GIC SpecialInvestments Pte Ltd, make private market investments. Overallguidance and ultimate approval of asset allocation rest withthe board of directors, which is composed of government min-isters and private sector leaders.

Mr. Sung next addressed some basic aspects of GIC’sinvestment strategy. He said that GIC’s long investment hori-zon allows them to forgo liquidity concerns and bear a higherlevel of risk in order to achieve greater returns on the nation’swealth. Also, he explained that GIC is required to invest inter-nationally because Singapore’s economy and capital marketsare so small. Accordingly, the fund invests in forty countriesworldwide, with approximately 40 percent allocated in NorthAmerica, 35 percent in Europe, and 25 percent in the AsiaPacific.

Mr. Sung lastly identified some key lessons from GIC’sexperience for Japanese policy makers to consider as theydebate the creation of an SWF. Most importantly, an SWF mustbe given one clear purpose: to achieve a specified long-termreturn target within risk limits. In order to carry out this man-date in an apolitical and professional manner, it is critical tohave clearly defined roles and responsibilities of the board ofdirectors, client, and management. Additionally, it is neces-sary to institute risk diversification across all asset classes,countries, sectors, currencies, etc. From a human resourcesstandpoint, Mr. Sung emphasized the need to recruit prom-ising individuals, encourage them to experiment and beinnovative, and retain the managers that display the mosttalent. Finally, he said very strong corporate governance isessential and must be paired with a risk management culture.

Yo Takeuchi, chief financial officer of the Development Bankof Japan (DBJ), first noted that technically the DBJ also qual-ifies as an SWF because, similar to the GIC, the governmenthas 100 percent ownership of the DBJ, yet it operates at arm’slength from the government according to carefully observedfiduciary responsibilities. Mr. Takeuchi conceded, however,that based on the DBJ’s investment strategy, it would not beconsidered a full-fledged SWF because it does not yield highenough returns. He said the other quasi-SWFs in Japan, includ-ing the GPIF and the foreign reserves, also could potentiallybenefit from more professional management, higher return tar-gets, and better asset allocation.

Mr. Takeuchi recalled his days at the Ministry of Financedealing with difficult taxation issues regarding foreign SWFand quasi-SWF investment in Japan. What he took away fromthis experience was that transparency is essential for sover-eign investments, and he said Japan must also provide adequatetransparency when managing public assets. Additionally, a keymatter for Japan to decide, he said, is whether it is politicallyfeasible to employ foreign managers to invest Japan’s publicassets. The potential for actual or perceived conflict of inter-est has recently been demonstrated with Middle Eastern SWFs,which have suffered heavy losses from investments that weremanaged by foreigners. Given that Japan is a nation in debtand does not have any natural resources, Mr. Takeuchi con-cluded that the first question Japan must answer before itcreates a true SWF is where the money will come from.

Session II: Japan as a Recipient Country: Experience and ObservationsTakeshi Isayama, chairman of Carlyle Japan, traced Japan’spost–World War II history as a recipient of foreign capital. Heidentified three stages of Japanese government policy andattitude toward foreign capital that have changed accordingto Japan’s economic environment. The first phase was char-acterized by government control over the inflow of all foreigncapital, which it restricted it to only what was deemed nec-essary. Beginning in 1950, the government passed a law limitingthe investment ratio of foreign capital to 50 percent and pro-hibiting it entirely in some industries. Later, in 1961, thegovernment altered its policy slightly to allow IBM to establisha subsidiary in Japan, thereby permitting 100 percent foreigncapital investments, under the condition that no profit wasremitted abroad.

The second phase began in 1964, when Japan becamea member of the IMF and the OECD and had to comply withobligations to liberalize the inflow of foreign capital. From 1967to 1973, Japan liberalized foreign direct investment in fivestages until, with exceptions, 100 percent foreign capitalinvestments were accepted. This precipitated a rapid increasein investment from U.S. and European companies during the1970s and 1980s. In Mr. Isayama’s opinion, the Japan gov-ernment generally dealt with foreign capital fairly during thisperiod in which its economic challenge was to assess the advan-tages and disadvantages of multinational companies investingin Japan, and to help Japanese companies compete globally.

The third stage, from the 1990s to the present, has beencharacterized by aggressive foreign capital investments andthe further globalization of the Japanese economy, businesses,and capital markets. In the wake of the bubble economy, thishas been an era of systemic reform toward U.S. and, particu-larly, European norms. Beginning in 1996, Prime MinisterHashimoto carried out a “big bang” of reforms that significantlyderegulated the Japanese stock market, as well as other finan-cial sectors and markets. Mr. Isayama described this as a painful


process, but said the manifestations of these reforms havebeen corporate restructuring, mergers and acquisitions,increased competitiveness of Japanese companies, and greaterdemand for foreign capital. Recent reforms such as the CompanyLaw, which was passed by the Diet in 2005, have continuedthese positive trends, according to Mr. Isayama. With an agingJapanese society, he stressed that foreign investments areneeded to achieve economic growth.

Mr. Isayama finished his presentation with observationson financial capitalism in the twenty-first century. He saidthe challenge at both the national and global level is to learnfrom the current financial crisis and build structures that donot permit the decoupling of the economy with financial cap-italism. Maintaining the free flow of capital is critical, butjust as traceability is required of corporations for manufac-tured products and services, he suggested the same mustbe true for financial products.

Takehiko Nakao, senior deputy director-general of theInternational Bureau, Ministry of Finance, Japan, discussedsome of the general issues countries face with respect toaccepting foreign SWF investment, and also the importanceof inward FDI to Japan’s economy. Mr. Nakao noted that assetsunder the management of SWFs worldwide are between 2 and3 trillion USD, and therefore the investment decisions of thesefunds can have significant effects on financial markets. Hehighlighted concerns of recipient countries specific to SWFsthat are being addressed by the G7 and OECD, including gov-ernance, risk management, transparency, and accountability.In turn, governments have also recognized the importance ofnondiscrimination toward SWF investment, transparency withrespect to future legislation on SWF investment, and protect-ing national security without being protectionist. Mr. Nakaomade the point that because SWFs are essentially massiveaccumulations of current account surpluses that cannot beinvested domestically, it is productive for all parties if the fundsare reinvested in industrialized countries in ways other thangovernment bonds.

According to Mr. Nakao, Japan must be open and nondis-criminatory toward all inward FDI, including SWF investment.Even though Japan is a current account surplus country, heagreed with Mr. Isayama that Japan needs foreign capital tofoster economic growth. He said there is political consensusthat inward FDI needs to be increased, and the current tar-get is to raise the level from 2.5 to 5.0 percent of GDP by 2010.

He went on to emphasize that, in his opinion, Japan’s reg-ulatory regime is very open to foreign capital. While many ofthe opposite view cite the case of The Children’s InvestmentFund, based in the UK, which was banned from acquiring a 20percent stake in Electric Power Development Co. (J-Power)according to the Foreign Exchange and Foreign Trade Law, Mr.Nakao noted that this was the only foreign deal prohibited outof 760 applications. In support of his view, he also highlighted

recent actions by the government to ensure nondiscriminationtoward foreign capital with respect to the privatization of NaritaAirport, and he agreed with the recent JETRO report sayingthat the real barriers to increasing inward FDI in Japan are lan-guage, high taxes, labor costs, and cultural differences.Furthermore, he said Japan requires new management tech-niques and business models, and increased shareholder rightsto attract foreign capital.

Takatoshi Ito, professor at the Graduate School of Economics,The University of Tokyo, began by speaking in greater depthabout the privatization of Narita Airport, on whose economicadvisory board he has served. Professor Ito explained that theprivatization of Narita Airport is important to understandbecause it embodies all Japan’s problems with respect toaccepting foreign capital. The Ministry of Land, Infrastructure,Transport and Tourism (MLIT) initially proposed that foreigncapital investments in Narita Airport be restricted to 30 per-cent. According to Professor Ito, this would require the samerestriction to be placed on Haneda Airport, which is already20 percent foreign owned. MLIT offered many reasons forrestricting foreign capital that reflected concern over nationaleconomic and security interests. However, the advisory boarddecided that foreign capital restrictions were unwarrantedbecause the concerns raised were either ineffectively addressedthrough such restrictions or better addressed through sepa-rate laws.

Professor Ito also addressed the issue of the regulatorytreatment of foreign SWF investment, as opposed to that offoreign private funds. The primary concern over SWF invest-ments, which has been articulated most forcefully by the UnitedStates and echoed by Japan, is that a country will invest forstrategic reasons rather than solely for profits. One hypothet-ical example of this would be an SWF investing in foreigncompanies with the intent to influence those companies in amanner that gives a competitive edge to their own domesticcompanies. Another such example would be a nondemocra-tic country’s SWF investing with sinister intentions that posenational security risks. Aside from these broader national inter-ests of the recipient country, if an SWF invests with any suchstrategic motives, it creates a conflict of interest with othershareholders that are profit driven.

In addition to concerns about potential strategic invest-ing, Professor Ito said there is fear that SWFs will engage inshort-term profit seeking, such as asset stripping, which, giventhe size of SWFs, could be economically devastating to smallercountries. Professor Ito noted that hedge funds already engagein this type of activity and yet many countries only regulateSWFs in this respect, despite the fact that SWFs have explic-itly stated their long-term strategies. If short-term profit seekingis a legitimate concern, there is no satisfactory argument beingproffered for why such regulations should discriminate againstSWFs, according to Professor Ito.


John Ehara, CEO of Unison Capital, Inc., concluded the paneldiscussion by offering his perception of SWF intentions andbehavior based on his experience as a manager of a fund inJapan that SWFs invest in. He began by pointing out that,despite all the concern about how SWFs invest in companies,SWF investments have actually been weighted heavily towardreal estate. This type of inward investment can be beneficialfor Japan because it bolsters real estate prices in metropoli-tan areas like Tokyo in the absence of domestic investment.Mr. Ehara said that SWF direct investment in Japanese com-panies has been very limited and will probably remain so, as heanticipates SWFs will continue to invest through funds like his.

On the whole, there is little SWF interest in investing inJapan, and the investment that does occur is done in a verysophisticated manner based on extensive expert analysis ofthe investment opportunities in Japan, according to Mr. Ehara.He said that in his experience the focus of SWFs is alwayson economic returns first, and any strategic considerationsare significantly less important. Moreover, he suggested, thesestrategic considerations tend to entail not monopolistic ornational security motives, but more benign intentions suchas investing in green or manufacturing technology. In all thecases he has known, there has never been any intention bySWFs to strategically influence the management of companies.

Mr. Ehara finally addressed what he understands as twokey challenges for SWFs investing in Japanese companies.First, Japanese companies are notoriously opaque with respectto investment opportunities. Many such deals will not occurthrough public auction; they require inside sources of informa-tion. SWFs must have these sources to identify investmentopportunities and to initiate dialogue with companies to deter-mine if the management and shareholders are open to SWFcapital. Second, as foreign investors, SWFs have the diffi-cult challenge of assessing the corporate governance ofJapanese companies they may potentially invest in.

Session III: Creating a Fund Management Industry in JapanBill Wilder, president and CEO of Nikko Asset ManagementCo., Ltd., began by summarizing what it takes to build an assetmanagement company in Japan, which he said is no differ-ent from any other country. It first requires a willingness tospend the money necessary to attract a high-quality staff, builda brand, and survive long enough to grow roots. Second, anasset management company must have an investment prod-uct that performs well and is targeted toward the needs of thelocal market. Mr. Wilder then addressed the issue of buildinga fund management industry in Japan by commenting on whathe identified as four key components of the industry: (1) a pro-gressive and responsive regulator; (2) active and competentindustry participants; (3) broad, effective, and reliable distri-bution channels; and (4) a large and well-educated investorbase that understands the importance of investing and isaccepting of some risk.

On the first component, Mr. Wilder said, the Ministry ofFinance and the Financial Services Agency (FSA) have donea very good job deregulating and policing the industry, despiteseveral instances in the past in which he disagreed with theirdecisions or the speed of their reform. He suggested thatthe discussion of regulators should be expanded to include TheInvestment Trusts Association (ITA), the Investment AdvisersAssociation (IAA), the Japan Securities Dealers Association,and various stock exchanges and banking associations thatasset managers have to deal with. He singled out the ITA andthe IAA, which are self-regulatory bodies, one or both of whichasset managers must join, and he urged that the process ofmerging the two associations be accelerated. This will bene-fit the industry by permitting a single entity to handle all assetmanagement issues with respect to regulators, the public,other associations, and the stock exchanges.

Regarding industry participants, Mr. Wilder said that theforeign financial services community and the U.S. Embassyhave been the greatest forces for the deregulation that hasoccurred in Japan. He mentioned that there is a committedgroup of professionals that will continue to provide leadershipon many of the issues that must still be addressed in orderto growthe industry and betterserve the interests of Japanese investors.

The third point, distribution channels, is critical for theindustry’s success, and Mr. Wilder stressed that both retail andinstitutional approaches are viable in Japan. For investmenttrusts, he said, asset management companies in Japan canchoose direct distribution, which is expensive and competi-tive, or use intermediaries such as brokers, banks, insurancecompanies, and even the post office to distribute investmentproducts. A segment that has not developed in Japan is thatof independent financial advisors.

Finally, Mr. Wilder discussed the differences in the expe-rience levels and risk attitudes of institutional investors andretail investors in Japan. Institutional investors are very expe-rienced and understanding of the risks, though he noted thatthey must improve their asset allocation and the developmentand retention of their investment staff. Retail investors aregenerally risk averse, especially older investors who havehad bad experiences. Given the extraordinary amount of assetsheld in cash or savings deposits in Japan, there is potential forthe present investment asset pool to grow fourfold, accordingto Mr. Wilder. He encouraged the industry to work in coordina-tion to educate retail investors on risk, diversification, and thetax implications of investment decisions.

Junichiro Sano, CEO of Dalton Investments KK, describedsome deficiencies of the Japanese fund management indus-try, and suggested that the creation of an SWF would be animpetus to improving the industry. Mr. Sano began by notingthe importance of understanding the history of Japan’s fundmanagement industry, including its cultural infrastructure,to understand the ways it must evolve to be globally compet-itive and capable of managing the nation’s wealth. Until the


mid-1990s, consensus decision making and strict rules forasset allocation ratios characterized Japan’s fund manage-ment industry. Mr. Sano said this began changing somewhatwhen foreign capital began to flow into Japan, which helpedprofessional fund managers, analysts, and traders becomepart of the fund management industry’s infrastructure. However,he argued that Japan remains a culture highly influenced byConfucianism and its island geography in ways that impedethe creation of a dynamic fund management industry. Investingrequires risk taking, the desire to make money, and individual-ism, all of which run counter to the Japanese way of thinkingand must be fostered through education, according to Mr. Sano.

In particular, Mr. Sano said corporate structure and com-pensation policies should be changed to permit quicker decisionmaking and greater risk tolerance, and should demand higherperformance by rewarding it with appropriate remuneration.These changes will help develop the professionalism of Japanesefund managers and make the Japanese fund managementindustry more competitive. He added that the Japanese mustlearn foreign language skills, embrace cultural diversity, andadopt a more global perspective. Without overcoming thesedeficiencies, Japanese fund management companies willnot be able to compete in the global market.

Mr. Sano said an SWF’s primary importance is to increasethe nation’s long-term wealth. He argued that Japanese entre-preneurs and corporate managers are too concerned withprotecting their own interests and they, along with all Japanese,should appropriate greater value to the interests of future gen-erations. Specifically, he suggested that an SWF be used toinvest in new and existing Japanese companies to make themglobally competitive. Lastly, Mr. Sano expressed regret thatwhen it comes to the value of the Tokyo Stock Exchange andthe nation’s wealth, Japanese prime ministers tend to be tooignorant and unconcerned. He said that in order to have a suc-cessful Japanese SWF, the private sector must take the initiativeto combine the best practices from Japan and abroad, andbecome greater producers of wealth.

Mamoru Taniya, CEO of Asuka Asset Management, Ltd.,described how fund management businesses must evolve withthe market. He said the era of mass production in investmentpractices, where relatively few investment funds made hugeprofits by devoting large amounts of money to research andother corporate infrastructure, is over. Mr. Taniya explainedthat in the past these funds would inevitably make large invest-ments in similar positions. When something went wrong, thefunds could not easily get out, because, excluding their posi-tions, there was little liquidity in the market. When they did exittheir positions, it caused prices to collapse. The end of this erahappened first for arbitrage practices, as exemplified in 1998by the failure of Long-Term Capital Management. Mr. Taniyasaid the same thing happened to small-sized stocks in 2006in Japan, and is now happening in the global commodity mar-ket and the U.S. mortgage market.

Whereas the mass production era created high barriers toentry into the fund management industry, now knowledge ismore widely available, and the key to a fund management com-pany’s success, said Mr. Taniya, hinges on its ability to offerdifferentiated value by taking advantage of each individual’sskill set and talents. This is not a phenomenon unique to Japan.Fund managers and fund management businesses everywheremust constantly reinvent their strategies, as market funda-mentals are constantly in flux. He added that these cycles ofchange are becoming shorter.

Mr. Taniya pointed out that Japanese fund managers haveproven themselves capable of excellence in many foreign invest-ment institutions. The Japanese fund management industry’smain problem, in his opinion, is that it does not have the nec-essary corporate systems to take advantage of the talentedindividuals available. However, he said, the development of thefund management industry also depends on cultivating a largerpool of young people eager to enter the industry. He concludedby agreeing with his fellow panelists that Japan’s fund man-agement industry has great potential for growth, but he saidthe right decisions must be made to unlock it.

Clifford Shaw, advisor to the Program on AlternativeInvestments, Center on Japanese Economy and Business,offered his perspective on some Japanese attitudes and cul-tural factors that affect the asset management industry. Hefirst addressed the Sakoku period, from 1633 to 1853, whenJapan was in near total isolation while trade and immigrationwere expanding elsewhere in the world. He credited this periodof isolation with some of the prevailing cultural attitudes men-tioned by the previous speakers, mainly Japan’s negative attitudetoward immigration and difficulty with diversity, and theJapanese people’s lack of familiarity with foreign languages.He also commented that the attitudes of the Japanese bureau-cracy, and the attitudes of the Japanese public toward thebureaucracy, may be a remnant of the Sakoku period. Mr. Shawthen noted two further anachronistic attitudes in Japan thatrun directly counter to essential elements of creating a strongfund management industry. One is that there is still a strongpreference for manufacturing physical goods rather than shift-ing to produce services and soft goods—a characteristic thatmakes Japan unique among developed countries. The other isthe attitude that it is somewhat improper to have a desire tomake money.

Mr. Shaw agreed with previous speakers that Japanesetend to be risk averse, and he attributed this to a fear of fail-ure. He ventured that the Japanese education system, whichplaces tremendous importance on exams, is an important con-tributor to the fear of failure. He also noted that the Japaneselegal system is far more unforgiving toward bankruptcy whencompared to Anglo-Saxon countries. These commonplace atti-tudes in Japan compound the universally painful feelingsassociated with losing money that are inevitable in fund man-agement. From an individual investor standpoint, Mr. Shaw


ventured that the risk-averse attitudes of Japanese have beenshaped by the large financial losses that occurred during thebubble period.

According to Mr. Shaw, Japanese corporate culture is par-ticularly inconducive to efficient fund management. Japanesesalarymen are generally very loyal to their company, and theybecome generalists as they rotate jobs in different depart-ments over the years. Mr. Shaw described the example of aJapanese trust bank where the general manager of the humanresources department was reassigned as the general managerof the asset management department. This is very contrary tothe Western idea that fund management is a specialist occu-pation that requires years of building expertise. Mr. Shaw furthersaid that this expertise has generally not been appropriatelycompensated in Japan, but this started to change when for-eign firms began poaching the best Japanese fund managers.He finished his presentation with the encouraging observationthat there is an increasing emphasis in Japanese companieson specialist training and recruitment of individuals well suitedfor fund management.

Closing Keynote Speech: The Multilateral Policy Response to SWFsRobert Kaproth, U.S. financial attaché and representative ofthe U.S. Department of the Treasury in Japan, began by prais-ing the multilateral efforts of SWFs and recipient countriesof SWF investments to address the many legitimate policyissues on both sides and foster a more open and transparentglobal financial system. Building off a trilateral agreement inMarch 2008 between the United States, Singapore, and AbuDhabi, the IMF has facilitated an international working group(IWG) of twenty-six SWFs to discuss investment principles,and the Organization for Economic Co-operation andDevelopment (OECD) has developed principles for inward invest-ment regimes.

Mr. Kaproth described the IWG discussions, which pro-duced a set of “generally accepted principles and practices”for SWFs, also known as the Santiago Principles. In his view,this represents an important first step by SWFs in allying thegrowing fear among many policy makers in recipient countriesabout the size, objectives, and transparency of SWFs. Heexplained that the Santiago Principles consist of twenty-four principles, divided into three chapters. The first chapteraddresses the legal framework, objectives, and coordinationwith macroeconomic policies of SWFs, which has helpedalleviate concerns that SWFs—particularly noncommoditySWFs—will perpetuate contentious macroeconomic and finan-cial policies. The second chapter articulates best practiceswith respect to institutional and governance structure in orderto ensure recipient countries of the SWFs’ operational inde-pendence. It also mitigates recipient countries’ fear of sinisterpolitical influence in investment decisions by SWFs. The thirdchapter outlines standards for SWF investment frameworks

and risk management—including disclosure of asset alloca-tion, benchmarks, and historical rates of return—with the aimto promote responsible investment and accountability. Mr.Kaproth noted that the credibility of the Santiago Principles isenhanced by the fact that the IWG encouraged input from recip-ient countries throughout the process.

Next, Mr. Kaproth described the complementary work con-ducted by the OECD to develop broadly accepted principlesthat foster open investment policies in countries that receiveSWF investments. He said this timely initiative was intendedto preempt any protectionist outcomes from the ongoing intensepolicy debates over SWFs in many recipient countries. The firstkey principle of the OECD investment code holds that coun-tries should not discriminate between domestic and foreigninvestors, which Mr. Kaproth noted is the foundational openinvestment principle. Further, he emphasized that this fun-damental principle can be applied in a manner that allowsgovernments to address legitimate national security concerns.The second and related principle is regulatory proportionality,which dictates that any measures taken to address nationalsecurity should be designed specific to the transaction in ques-tion, rather than applied as a broader regulatory policy, suchas sectoral restrictions that inevitably restrict many unprob-lematic investments. The third principle mentioned by Mr.Kaproth is transparency. This principle compels governmentsto be forthright in explaining the investment review processand its objectives, and to be fair and predictable in its imple-mentation of policies. The final principle is accountability, whichMr. Kaproth explained means that governments should employadequate oversight of the official implementing the investmentreview process to prevent political interference.

After addressing these recent multilateral policy mile-stones, Mr. Kaproth discussed the potential creation of aJapanese SWF. He was clear that the United States doesnot take a position on the matter because it is a sovereign deci-sion for the Japanese government. Therefore, he offered generalobservations that would apply to a Japanese SWF as well asall other SWFs. First, the United States expects all SWFs toadhere to the Santiago Principles. Second, he said a nation’spublic must be educated in the risk return tradeoff inherentin SWF investments. This is important to maintain the medium-term viability of an SWF in case there are losses. Lastly, hediscussed the significant differences in asset liability struc-tures of commodity and noncommodity SWFs. He explainedthat commodity funds are usually derived from foreign cur-rency, which does not require sterilization by the central bankand therefore does not have any liability. Conversely, noncom-modity funds’ assets are often sterilized and have liabilitybecause they are derived from exchange rate intervention.Accordingly, noncommodity SWFs must factor the yield paidon the sterilization debt when calculating the net return. Mr.Kaproth acknowledged that this is something being given care-ful consideration in the current debate over a Japanese SWF.









Center on Japanese Economy and BusinessColumbia Business School

321 Uris Hall, 3022 Broadway

New York, NY 10027

Phone: 212-854-3976

Fax: 212-678-6958

Email: [email protected]

http://www.gsb.columbia.edu/cjeb

Sponsors of the Center on Japanese Economy and Business

Lead Corporate SponsorsSumitomo Corporation of America

Senior Corporate SponsorsDaiwa Securities America Inc.

Major Corporate SponsorsKikkoman Corporation

RISA Partners, Inc.Saga Investment Co., Inc.

Takata CorporationTsuchiya Co., Ltd.

Corporate SponsorsAFLAC Japan

Caxton Associates, LLCJapanese Chamber of Commerce & Industry of New York, Inc.

Mitsubishi International CorporationMitsubishi UFJ Trust and Banking Corporation

Mitsui Sumitomo Insurance Company, Ltd.Mitsui USA FoundationMori Building Co., Ltd.

Pacific Investment Management Company (PIMCO)The Tokyo Electric Power Company, Inc.

Yaskawa Electric Corporation

Individual SponsorsRobert Alan Feldman

Shigeru Masuda

Friends of the CenterJohn and Miyoko Davey

Sumitomo Chemical CorporationSadao Taura

Sponsors of the Program on Alternative Investments

Lead Corporate SponsorsDaido Life Insurance Company

Nomura Holdings, Inc.

Corporate SponsorsAdvantage Partners, LLP

Documents

Center on Japanese Economy and Business Japanese Government...Center on Japanese Economy and Business Japanese translation inside Opening Remarks Alicia Ogawa, Senior Advisor,