Diversification of investment and independent ("emerging") asset managers

Please allow my strange English... because it is produced with Google translation. (Please do not laugh ;) my Japanese is also strange... ) The original article is here.

On August 28, the Cabinet Secretariat's New Capitalism Realization Headquarters announced the final version of the Asset Owner Principles, which are set out in the Plan to Realize an Asset Management Nation. The same policy plan also includethe Emerging Asset Manager Promotion Program (Japan's version of EMP) for the new entries asset managers, and both are linked. The Financial Services Agency (FSA) has been calling on financial institutions to take steps regarding emerging asset managers, and on June 7th published on its website a list of "Initiatives for EMP" of financial institutions that have responded by announcing their policies. Also, on June 21st, the industries association published the list of emerging asset managers on the Financial Services Agency's website.?

The government is putting so much effort into promoting emerging asset managers.

The Progress Report on the Advancement of the Asset Management Industry, has been published by FSA since 2020, has cited challenges facing Japan's asset management industry, such as the fact that many are subsidiaries of financial institutions. There are few independents, and passive management is overwhelmingly prevalent, tends to be low profits, and is not fully fulfilling its role of discovering the investee companies' value and seeking to increase value through engagement. The report has highlighted the need for support for emerging investment managers and policies to encourage further entry by global investment management companies.

As for why the lack of independence is a problem, it is generally pointed out that there is a risk of a conflict of interest between affiliated financial institutions and clients, which is also stated in the Asset Owner Principles. However, as a factor in the Progress Report points out, "investors are unable to fully fulfil their role of seeking to increase the value of their investment targets," it is more likely that because they are subsidiaries of financial institutions, they mainly manage their assets within the group, which reduces the scale of their management compared to overseas, and thus prevents competition from functioning properly. It is not unique to Japan that asset management companies are subsidiaries of financial institutions; conversely, financial institutions need asset management departments. The problem is that this is the only option. As a result, it becomes difficult to create diversity in management, and the motivation to engage strongly to increase corporate value may also become less likely to increase.

Being emerging managers is a rare option in Japan

It is not uncommon to receive messages from overseas investors saying, "I have decided to leave XXX Asset Management because I have decided to start a fund with an acquaintance." Many of them are trying to manage their assets using unique evaluation methods and data, known as ESG or impact investing. They are an entrepreneur in the asset management industry. In the above list, there are 36 organisations, including those whose names do not suggest that they invest in listed stocks. The list of the names that registered the EMP of a US public pension with 800,000 beneficiaries, which will be described later, lists 1,300 companies.

A report published on May 20th by a research project by Nomura Research Institute aimed at revitalising independent asset managers introduces a case study of a fund that was started more than 15 years ago with the EMP program of CalPERS (California Public Employees Retirement System). Utilising his knowledge as a corporate governance expert at IFC (International Finance Corporation), he applied to CalPERS's requirement of "investing in small and medium-sized companies in emerging countries, improving governance and increasing corporate value" and launched a fund. CalPERS' initial investment was about 30 billion yen, but after a few years, with the emerging market boom, the fund gained new clients and grew to 300 billion yen. Such experiences are hard to find in Japan, but in the United States, EMP programs run by such funds support emerging/independent asset management companies.

So why do U.S. pension funds undertake EMP programs?

EMP is for investment diversity

The New York City Retirement System (NYCRS) serves approximately 800,000 participants and beneficiaries. With total assets under management of approximately $253 billion (as of June 2023), NYCRS is the fourth largest public pension system in the United States. NYCRS has a long-standing commitment to increasing its investments with minority- and/or women-owned (MWBE) and emerging asset managers. As of June 2023, NYCRS has allocated $19.5 billion (12.68% of active assets) to MWBE managers. NYCRS has also allocated $9.85 billion (3.89% of total assets) to emerging managers, up from 3.59% the previous year.

The purpose is to address diversity and equality among asset managers. "The integration of DEI into the investment process is based on extensive evidence showing that diversity improves decision-making, prevents the limitations of groupthink, and is associated with better performance and risk management," and "The lack of diversity in the asset management industry, as well as racial and gender wealth disparities, are risks to returns for beneficiaries," are also stated in the report published annually as part of the activity. This initiative also aims to promote diversity among the investee companies themselves.? All managers are asked to promote diversity on the boards of directors of investee companies and report DEI information.

NYCRS is focusing on recruiting diverse emerging asset managers because it believes it will help integrate DEI. It holds an annual conference for emerging managers, offering asset class-specific panels and speed networking sessions. These sessions provide MWBEs or emerging managers with the opportunity to communicate with the fund's emerging manager program staff and investment consultants. From the fund's perspective, this also strengthens the pipeline of new managers. NYCRS also registers these MWBEs/emerging managers in its database, which now numbers more than 1,300. According to NYCRS, their past performance has also exceeded the benchmark, and they plan to continue expanding in the future.

Hopes for a Japanese version of EMP

The purpose of the emerging manager program in the US is to seek diversity in investment, and just like the integration of DEI into investment, it is clear that it is by no means a "rescue program." It is for the purpose of improving long-term performance and reducing risk.

Compared to the US and other countries, it is difficult to say that there are many "diverse" asset managers in Japan. Emerging and independent asset management companies tend to start with a small number of people and have a small management scale. Naturally, we see cases where they carefully select small companies that are difficult for large companies to cover and engage with them. Even in the prime market, there are many companies listed on the Tokyo Stock Exchange that major institutional investors do not cover due to their small size. With an increase in such management companies, there is a possibility that management will become more active throughout the market. The EMP currently being undertaken by the government is the first step toward that goal. Although it is still a tiny step, it is strongly hoped that this activity will grow.