Stephen Givens is a corporate lawyer based in Tokyo.
Japanese asset managers, across a range of bench marks, substantially underperform their counterparts in the U.S. They also happen to be compensated less generously by several orders of magnitude. Is there a causal connection here?
An article on Japan's new government-sponsored university fund, " Japan's $90bn university fund struggles to draw talent despite size ," published in the Financial Times on Oct. 11, implied that there is.
The article contrasted the cumulative 3% return of Japan's Government Pension Investment Fund (GPIF), where the chief investment officer earns $270,000 annually, with the 11% return generated by Harvard University's endowment fund, whose chief investment officer is paid over $5 million.
In the article, Masakazu Kita, the recently appointed CIO of the university fund, sheepishly explained that the salaries a state-run fund can pay are well below international standards, but expressed the hope that "empathy" with its noble purposes will draw talented asset managers to work for the new fund.
We have heard this kind of advice before, mostly from well-meaning foreign friends of Japan. Lockstep compensation and lifetime employment, we are told, create the wrong incentives. If only Japan would compensate its own asset managers and senior corporate executives the way they are paid in the U.S., then chronically low Japanese returns on equity and invested capital would rise to equal America's.
In other words, if only Kita were paid $5 million a year, or had a Harvard-like $5 million or more bonus dangled before him, then the fund's returns would be closer to 11% than 3%.
This diagnosis and prescription are far too simplistic. I am reminded of Western academic explanations of Japan's low levels of litigation that became popular a few decades ago. Since human beings are equally prone to conflict and disputes the world over, the logic went, the only possible explanation for the failure of Japanese to assert their rights in court must be pent-up demand inadequately served by too few Japanese lawyers.
In reality, for both asset management and litigation, cause and effect are more complex. Each is a microcosm within the larger ecosystem of Japan itself. Artificially manipulating one variable -- asset manager compensation or the number of lawyers -- does not address the multiple other variables that contribute to low return on equity, low asset manager pay, infrequent litigation, or a small lawyer population in the first place. Correlation does not prove causation.
So, why does GPIF generate a paltry 3% return compared to Harvard's enviable 11%? The reasons are multiple and systemic.
Begin with the fact that GPIF is a mammoth $1.7 trillion state-run fund compared to Harvard's 50 times smaller $42 billion private endowment. For better or worse, GPIF operates within political constraints and serves political objectives beyond maximizing investment return alone.
GPIF operates within political constraints and serves political objectives beyond maximizing investment return alone. © Reuters GPIF's legally mandated asset allocation -- 25% evenly split among domestic equities, domestic bonds, foreign equities and foreign bonds -- hobbles it from the starting gate. That half of GPIF's funds must be invested in Japan automatically drags down its returns compared to Harvard, which has no ironclad allocation rules and currently has 60% invested in private equity and hedge funds.
Add to this the fact that GPIF relies on notoriously underperforming domestic asset managers affiliated with Japan's leading financial institutions to run its portfolio. The reasons why Japanese asset managers dismally underperform, analyzed in a recent Financial Services Agency report, are complex and reflect the Japanese corporate ecosystem itself.
According to the FSA report, domestic asset management companies are poor sisters of the insurance, bank or securities group to which they belong. Typically serving captive clients of the larger group, they have little need to compete on the basis of higher returns. Across the industry, investment approaches, strategies, portfolios and returns are boringly similar.
Completing the picture, portfolios are run by generalist lifetime employees rotated in and out from the parent company. Sound familiar? Why is anyone surprised that Japanese asset management culture and practice recapitulate corporate Japan itself?
The notion that paying the CIO or other investment professionals at GPIF or the new university fund "internationally competitive" rates, by itself, would translate into higher returns defies a complex reality.
One dimension of this reality is that U.S.-style mutual funds, hedge funds and private equity funds, together with the armies of highly paid MBA's, quants and analysts that populate them, simply never happened in Japan. The result is that Japan lacks investment professionals with the skills, experience and larger investment management culture of the U.S. Offering higher pay will not magically call into being skills and institutions that do not exist in the first place.
U.S.-style mutual funds, hedge funds and private equity funds, together with the armies of highly paid MBA's, quants and analysts that populate them, simply never happened in Japan. Offering higher pay will not magically call into being skills and institutions that do not exist in the first place.
None of this is to suggest that a corporate culture that rewards the CEO of General Electric with over $200 million is superior to one in which the top 45 senior executives of Hitachi are collectively paid less than $50 million. The point is simply that the causal relationship between executive pay and corporate performance is not obvious; more generally that history, culture and human motivation resist quick fixes.
If low return on investment is deeply woven into the Japanese ecosystem, it may be a condition without an easy remedy other than to ask the Japanese people to stop being who they are.