"Socialist" Policies Protecting Japanese Electricity Frustrates TCI

"My formula for success is to be found in three words - work - work - work."

Silvio Berlusconi
former Italian premier and media proprietor

More grit for the critics of Japan Inc. The irony is both perplexing and downright sad. In the aftermath of the last market upturn in 2003 (when the Nikkei 225 bounced around the 8,000 level) the authorities encouraged unofficially the movement that quickly took place in the name of corporate restructuring. The feeling was that much of Japanese mangement had grown fat and lazy and was not really focusing on shareholder value, especially as it related to focusing on core activities, cost savings, strategic vision and execution. Japan needed to change.

So along came the domestic and foreign corporate activists or "corporate raiders" according to the mainstream Japanese media. They were portrayed as selfish speculators out to make a quick buck at the expense of the innocent Japanese management and against the interests of Japan Inc's employees. Whatever happened to the interests of the company's shareholders?

As Scrooge would have said: Humbug, sir! Hedge fund assets devoted to investor activism fell from about US$15 billion in 2003/04 to probably under US$8 billion today.

Why the shrinkage in a strategy which typically guns for the 20-30% net of fee returns and typically outperforms their long/short equity brethren at 12-15%? Somewhere between the takeover and transformation of a second tier Japanese bank (LTCB into Shinsei) and the rehabilitation of a domestic auto manufacturer (Nissan by Renault) the stories soured and the media forgot about these "success stories".

Murukami, a prominent and vocal proponent of shareholder value was summarily charged with insider activity and his M&A Consulting with it's impressive list of U.S. and European institutional investors was shut down. Investors holding as much as US$4 billion bolted. Steel Partners was been similarly battered by the press and by its "targets" on the ground hiding behind the bureacratic cloak and legal system which still favors what some would call an unfair playing field.

Now comes the news that Chris Horn's TCI or Children's Investment Fund, with a 9.9% holding in a major Japanese utility JPower stands to lose millions. The company has refused to lift its dividend and has been abetted in its refusal by the Government's iron fist controlling electricity prices; and specificially by keeping electricity prices artifically low. So socialism is not dead!

TCI is now seeking to increase its stake in the utility to 20%, presumably to have more say on the JPower board. Apparently the Japanese Government is going to assess whether this is a "national threat" and get back to TCI sometime in May. Shame.

Of course TCI is taking a big gamble that Japan's stock market will rebound. But, the current global economy is not looking too favorably at further openess when it comes to certain strategic sectors. For example, the U.K. Government recently nationalized failed bank Northern Rock. Moreover, the political chatter in the U.S. has turned towards being more circumspect and potentially protectionist even if recent SWFs have been "allowed" to take stakes in major financial institutions (such as Merrill Lynch, Citibank and UBS).

TCI better button down its hatches and prepare to ride this investment for quite a while. Happily, continued upside nmovements in crude oil prices may add pressure on Japan's budget enough to result in domestic energy price hikes sooner rather than later. This might then help out TCI get what they want from the JPower board. If not, investors can expect short-term losses on some of these strategic investments by TCI and other activists.This might be just more reason for foreigners to abandon Japan and send the Nikkei sliding yet again. Japan still needs to change but by opening itself up not shutting itself in. Mahalo.

Even the Japanese Are Ignoring Japan

"People seem not to see that their opinion of the world is also a confession of their character."

Ralph Waldo Emerson (1803 - 1882)

Yet another sell-side brokerhas sounded the death knell on the Japanese equity markets. Welcome to the party 2 years too late buddy!

Analyst Nishizaki of HSBC in a recent note was sour on the Japanese economy for a number of reasons: (1) Corporate governance (which was already appalling) has deteriorated (2) Government policy mistakes appear to be tipping the economy into a recession (3) Japanese domestic funds are selling Japanese stocks and (4) Foreigners have been net sellers of US$24 billion worth of Japanese stocks since August 2007. According to the report foreigners now account for 70% of the transaction flow on the TSE.

The net result has been that the TOPIX Index is down 24% since late April to make the second consecutive fiscal year of negative returns.

With such negative vibes hanging over Japan look for an increasing number of hedge fund managers to use the market and sectors of that market as shorts for their pan-Asian portfolios. Fund of hedge fund managers take note; you too should be looking around for dedicated short sellers of Japanese equities. Then again, even that might now be too late. Mahalo.

Sub-Prime: The Albatross Around Japan's Financial Institutional Necks

" Labor to keep alive the little spark of celestial fire called conscience."

George Washington (1732 - 1799)
First U.S. President

Recent media reports out of Tokyo stated that the FSA (Financial Services Agency) have confirmed that losses incurred by Japanese financial institutions related to U.S. subprime doubled to approximately US$5.7 billion during the 4th quarter of 2007.

Additionally, the FSA upped the exposure of other Japanese banks, credit unions and other institutions to Yen1.52 trillion against Yen1.41 trillion in the third quarter. Yikes! Think about this? This does not even account for additional potential bad loss provisions that are likely if and when the monoline bond insurers "go down".

Implications? Clearly the Subprime Syndrome issue is a moving target; and likely to get worse not better. For the hedge fund community this might mean a closer look at the credit default swap levels on Japanese banks, insurers and other financial institutions for their relevant CDS rates to widen. It will also continue to weigh on their balance sheet reserves and ongoing quarterly reports and by implication their share prices and the market in general.

Lastly, with balance sheet constrained this is another potential reason why these "clients" are not expected to be buyers of global hedge fund of fund product in the near term. Mahalo.

Investment Consultant Shake-Up Coming

"British Airways has a Jumbo jet simulator, and landing it is exciting and dramatic. But think of being in a real Jumbo, with the pilot slumped dead beside you. That's the real element of life and death. That's what you get in business."

Adam Faith, former pop singer and businessman

The investment consultancy business model may be ripe for change. For a long time the so called big names of Mercer, Cambridge Associates, Callan, Frank Russell etc. provided advice and fund selection in the traditional space.

Some of them even stepped into the product creation space (Frank Russell) where they can get paid basis points on assets raised or performance produced, in much the same way as a fund of funds.

Then hedge funds and other complex alternative investments came along and their work became more complicated. It also meant that they needed to keep tabs on more managers in areas of the market that many of their employees had no experience. They became the first line of defense - the box checkers - for the institutional investors.

Today, news has leaked that a previously staid and steady database and ranker of mutual and hedge fund products has stepped into the investment consultant world. Morningstar has apparently replaced Mercer (Singapore) as the investment consultant for the pension fund of Singapore. If true, this would be a significant coup as well as a blow to the oligopoly of established players.

Although one might speculate on the specifics of the arrangement this is a clear indication that similar firms might consider a business model that represents large institutional clients and their interests. This is in contrast to the S&P, Moodys and Fitch rating business whose sad claim to fame is that they tend to be incentivized by the funds and banks that create asset-gathering structured products.This is a fundamental difference and may signal a change that will eventually be followed by the previously mentioned firms.

Is there a front-runner in this business, maybe not. Although a firm like Albourne Partners which is affiliated with the community website has made impressive gains with a number of institutional investors in the U.S. and Europe. Last year they also stepped up their activities covering hedge funds in Japan, presumably before chasing down institutional investors in that part of the world too. Mahalo.

Shrinking Japan Hedge Fund Assets Pummel Broker Stocks

"The only function of economic forecasting is to make astrology look respectable."

John Kenneth Galbraith
Economist and writer, 1908-2006

News continues to be lousy when it comes to Japan. According to recent data out of Eurekahedge, the Singapore-based hedge fund data and third-party marketing firm, Japan hedge fund assets are on the decline.

Japanese hedge funds lost a combined US$10.9 billion in 2007, through poor performance and after US$7.7 billion of investor redemptions, according to Eurekahedge.

Including US$22.4 billion of new money, Asian hedge funds outside Japan grew by US$35 billion to US$101 billion last year.

In the 2003-05 period Japan's hedge fund industry comprising Japan-focused, Asia-focused as well as globally-focused funds exploded to US$55 billion.

One clear implication of hedge fund assets falling off a cliff in Japan is to negatively impact the profitability of Japan's brokers. Transaction-related revenues are likely to continue their recent decline with the big picture that Nikko, Daiwa and Nomura might expect their respective share prices to remain under pressure.

For example, recent share price data from Bloomberg shows current stock price versus their 2007 high for Nikko Cordial (before delisting on 1/22/08) : Yen1,364 vs. 1,780 (minus 23%); Daiwa: Yen970 vs. 1,673 (minus 42%); and, Nomura: Yen1,609 vs. 2,870 (minus 44%).

Even for Sparx (the biggest Japan-based hedge fund shop in the region that is publically listed) the price action has reflected their poor performing Japan franchise so far this year with recent price at Yen39,000 vs. 120,000 high in 2007 or minus 67%.

Times are likely to remain tough among Japan's brokers especially in terms of pushing their synthetic prime brokerage operations in London and New York if firmwide balance sheets are shrinking and hedge fund assets continue to drop in Japanese financial markets. Mahalo.