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The DC debate continues

The latest official statements suggest the new private pensions initiative is expected to start later this year. In March, the finance minister said it was a top priority.The effective date of establishment is October, but others suggest it will more than likely come into force in April 2002.
This latest delay may have been inspired by lobbying from the traditional defined benefit (DB) record keepers and administrative players, who have realised that they may lose business to the defined contribution (DC) experienced providers.
Behind the scenes they have managed to delay the introduction of the pension law by suggesting that the service providers aren’t ready. For those who are gearing up to serve this market, it is hard to develop products on that basis.
The truth is that the asset management industry is no longer rushing headlong to meet the pension initiative, as they realise that it may take 10 years for them to start making a profit from it. Apart from the lack of fiscal incentives to draw investors from the security of their DB scheme, the pension initiative needs a fair wind in the markets, and there is not much prospect of that in the near term. However, by next year, all could be different, A change of government, or at least a change of President, may spark a new bout of optimism.
Big firms such as Hitachi have realised that they need to begin offering DC schemes as soon as they become available.
But the question remains, when you look at the DC model, what is the attraction for the employee? And the DC plan has a tax problem; DB is fairly tax efficient in that there are very few cases where there will be a tax charge, and investment returns are tax free. The DC plan’s tax benefit is limited. The contribution limited is too low and matching of contributions is not allowed.
Obviously for the employer, the DC scheme means a reduction of risk. Another variable is the attitude of trade unions to the transfer of staff to DC. If they decide to veto it, that will be another major obstacle.
The likelihood is that employers will introduce it for new recruits, especially graduates, who will then have the advantage of pension mobility. Although mobility of labour has increased in Japan, it is still low compared with other countries, especially for anyone over 40.
This highlights another factor that may hamper the development of DC pensions; that the people with most of the money are the over 50s. Younger people, even those with good jobs, do not have the disposable income or money to put into investment trusts. And they certainly don’t understand risk and return issues.

There is certainly an argument that for older employees it’s difficult to move. The solution is probably additional salary or an additional component over and above the DC plan, to make it sufficiently attractive.
How will the potential buyer react to the high fees implicit in a DC scheme?
The management fees for a DB plan are around 35-40 basis points, whereas the DC plans may require a fee of 1%. It is not officially announced, but one insider suggested the fees could be as high as 1.5%.
The charging issue is complicated by the fact that the large brokerages have not been able to make a charge for the giving of advice.
As a result, the business is skewed towards the maximum commission that guarantees the long-term profitability of the brokerage. This is churned and burned in the ‘normal’ course of brokerage business in Japan.
So the market will start slowly, which is unfortunate for the fund management groups, all of whom launched new funds last year to capture the expected flood of money freed up from postal savings accounts, as a precursor to breaking into the pension market.
The foreign players were beguiled by the idea that Japan was going to have its own 401k type boom, and that trillions of extremely conservative postal savings money was going to flood the equity market.
Some of it did, of course, with disastrous consequences. Nomura Securities started the biggest of the new funds, raising some Y1.5trillion yen, which looked rather impressive until the asset value of the fell by 40% last year.
Not having had DC and bank distribution of funds has certainly hampered of the development Japan’s retail market. But when DC comes, the education that must come with it will raise the sophistication of investors.
For the moment though, active management strategies will be wasted on most Japanese investors. Most of the money will go into guaranteed fund products, which is clearly wrong for young investors. But to some more seasoned observers, that just illustrates that the risk-averse Japanese employee is not going to go into a DC plan anyway.
That is the great conundrum; trillions of Yen waiting to be invested in low yielding, low risk – and low margin – products.

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