IMPENDING DEREGULATION INCREASES YEN FOR JAPAN: U.S. MONEY MANAGERS SEE IT AS MARKET OF THE RISING SUN

Merrill Lynch & Co. has spent 35 years navigating Japan’s nightmarish regulatory system and old-boy business alliances. So it isn’t shedding tears over the coming elimination of such charming local customs as fixed commissions, which in the past had encouraged some Japanese competitors to offer kickbacks to their biggest customers.

But as Japan’s long-awaited financial deregulation approaches, the New York-based brokerage may look back somewhat fondly on the days when arcane barriers kept competitors from home at bay.

That’s because competition from other Americans is coming fast and furious. Dozens of companies are scrambling to set up shop — despite the high cost of doing business and the inevitable missteps that will leave some players with sake hangovers.

“Japan is an expensive play,” says Karina J. Istvan, a consultant research firm Cerulli Associates Inc. in Boston. “But with the size of the market” — 126 million consumers with $12 trillion in savings — “it’s too big to ignore.”

Under pressure from U.S. trade negotiators, and feeling the squeeze of a near-decade-long slump, the Diet has lifted rules prohibiting non-Japanese investment managers from running pension fund money and selling directly to individuals.

But the so-called “Big Bang” hits April 1, when rules that chilled retail and pension fund investing in non-Japanese stocks are scraped.

U.S. companies are also salivating in anticipation of this fall, when Japanese banks — which have long had a tight grip on the retail market — will be allowed to sell mutual funds as the regulatory barriers separating the banking, securities and insurance industries crumble.

In addition, Japan’s economic crisis has foreign companies looking to scoop up battered financial institutions at fire-sale prices.

merrill hiring 2,000

Having picked through the remains of collapsed Yamaichi Securities Co., for instance, Merrill is launching Merrill Lynch Japan Securities Co. It plans to open 30 retail bran
ches across Japan this year and will hire about 2,000 employees, including many former Yamaichi brokers, bringing its employees in Japan to 3,000. The deal comes on the heels of last year’s acquisition of London-based Mercury Asset Management, which gave Merrill a strong retail presence in Japan.

“The blood is running in the streets now in Japan,” says Salomon Smith Barney executive Frank Campanale of the economic woes that have made it easier for foreign companies to gain a foothold.

Other U.S. companies in Japan or seriously contemplating a move there include Alliance Capital Management LP, American Express Financial Corp., Bankers Trust Co., Citibank, Federated Investors, Fidelity Investments, Invesco, J.P. Morgan Investment Management Inc., Morgan Stanley Dean Witter Discover & Co., Mellon Bank Corp., Putnam Investments, SEI Investments Co. and United Asset Management Corp.

Many have made inroads in the country’s $2 trillion pension fund market, serving as money managers or advisers. Now they are setting their sights on individual investors, who control six times as much.

grass is greener

Foreign money managers touting the fat returns of funds investing outside Japan are sure to get attention at home. The Nikkei 225 index was down 56% last week from its all-time high of 38,915 in December 1989. Meanwhile, almost half of all savings deposits in Japan are held in postal accounts, which return a guaranteed 1% to 3%.

Scared by the prolonged bloodbath in domestic stocks, many investors fled to certificates of deposit and savings accounts, but as lifetime jobs evaporate, they are planning for their retirement more aggressively.

“The well-deserved reputation of U.S. money management firms should be enough to persuade people that it makes sense for them to consider putting their retirement money in the hands of foreign players,” says Drew Collins, a senior vice president at Boston-based Federated, which is discussing potential sale of its load funds with Japanese companies.

The pr
oliferation of investment vehicles is expected to create an even greater demand for advice and other services as consumers try to sort it all out. Indeed, mutual funds are still a relatively new concept, partly because Japanese banks have never sold them.

Despite two previous missteps, Morningstar Inc. is exporting its star rating system for mutual funds through a joint venture with Tokyo-based software company Softbank Corp. (InvestmentNews, Feb. 2).

Smith Barney, meanwhile, is hoping Japanese investors are not the do-it-yourself types. Its Wilmington, Del.-based consulting group, headed by Mr. Campanale, has formed a joint venture with Nikko Securities Ltd. to sell the group’s fee-based wrap accounts.

In anticipation of an April rollout, Smith Barney has been training Nikko brokers to serve as financial advisers who will work with clients on a continuing basis. The move is meant to counter suspicion of brokerages following scandals like the Yamaichi debacle.

“The Japanese investor has developed an inherent distrust for securities firms,” says Mr. Campanale, comparing the climate in Japan to the United States during the bear market of 1973-74. “This way the broker goes from being more than a middleman to a true financial consultant.”

Smith Barney will have to compete with Japanese firms that are making forays into the advice game. The Tokyo-based Japan Association for Financial Planners — licensed by the Certified Financial Planner Board of Standards in Denver to award its CFP designation — is providing financial planning education for thousands of nippon and nomura agents.

Its membership has swelled to 20,000, up from 136 when the association was founded in 1987, and about half are agents working for banking, insurance and other financial services companies.

“Due to the deregulation, there are going to be a lot more complicated investment products,” says Suzue Sato Nisco, the Japanese association’s U.S. representative in Denver. “Many people are afraid to loos
e more money and they would like to have professional financial advisers.”

Foreign companies are also grappling with cultural differences that pose the biggest challenge to direct distributors, like Fidelity and Merrill Lynch. Fidelity has been selling funds through Nikko and Nomura, but has announced plans to market directly to consumers, although specifics are not available.

In Japan, most investment decisions are made by women, a market that U.S. companies are still learning to target.

In addition, there aren’t as many personal computers as in the United States. Household penetration of the Internet, for instance, is an estimated 9.9% in Japan, vs. 21.3% in the United States.

Some U.S. companies are seeking to get banks to sell their funds, thus avoiding the expense of building sales networks.

joint venture

Last month, for example, the Dreyfus Corp., the mutual fund subsidiary of Mellon Bank, and Tokyo-Mitsubishi Asset Management, an affiliate of the Bank of Tokyo-Mitsubishi, agreed to create and distribute mutual funds. The first is a balanced fund, to be rolled out this month.

Banks are considered an untapped resource, compared to brokerages, which want only foreign companies than can round out their already ample offerings.

“Some of the Japanese asset managers have (unsuccessfully) tried direct distribution,” adds Cerulli’s Ms. Istvan. “It will be interesting to see if the market has changed enough to where (Fidelity and others) will have success.”

Even some American companies that sell funds through local brokerages are scrambling to align themselves with banks.

“We will certainly be looking to expand distribution through banks,” says Steven Speigel, Putnam’s director of corporate development for international joint ventures.

Boston-based Putnam, which has $6 billion under management in Japan (about 2.5% of its total), sold its first fund in Japan 26 years ago through Daiwa Securities Co. and has since lined up a bevy of domestic brokerage s to pitc
h its products.

“We don’t know yet whether the U.S. model of multiple product distribution through a single entity, as opposed to proprietary fund products, will emerge. We think it will,” says Mr. Speigel.

Such uncertainty bodes well for Japanese firms, who are benefiting from multiple partnerships with foreign money managers. Nikko Securities, for instance, has sales agreements with Smith Barney, Fidelity and Goldman Sachs & Co., according to Cerulli.

In the end, however, the scramble for the market may be somewhat premature. Some laws that make American executives roll their eyes aren’t going away anytime soon. One rewards insurance company branches that boast strong sales of government bonds with the right to offer other products.

“(Deregulation) needs to happen at a much more rapid rate,” says Mr. Collins of Putnam, which last June struck a distribution agreement with insurer Nippon Life Group. “They are moving in the right direction, just at a glacial pace.”

The rush reminds U.S. firms sitting on the sidelines of the frenzy to get into Mexico, South Korea and Thailand — before those markets blew up.

Still, Japan is the world’s second-largest economic power, making such comparisons almost meaningless, says Anil Kashyap, a professor of economics at the University of Chicago’s Graduate School of Business. “Japan is a much bigger, healthier and stronger economy,” Mr. Kashyap says, “even given the current mess they are in.”