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Noriyuki Morimoto's Blog

International Equity Returns Distorted by Japan’s Bubble Economy

Jul 02, 2018
byNoriyuki Morimoto

The global economy has integrated into one, as companies increasingly became multinational or lost national identities. It is the time of global equities without borders. The asset category of international equities, which is based on the distinction between equities of one’s country and equities of others, is a thing of the past. Nevertheless, until quite recently in Japan, international equities, not global equities, were the mainstream. Suppose during that time, a Japanese investor attempted to choose a management firm with which to invest in international equities (from a Japanese perspective). The investor would find that actually very few firms manage such assets. Neither do they have much experience in managing global equities. The useful information turns out to be management results of international equities, from a US perspective. In the 1980s, when Japan went through the so-called bubble economy, how to treat Japanese equities was a tricky question for other countries. Especially with international equities from a US perspective, the weight of Japan had become overwhelming. At that time, many of the management firms were viewing Japanese equities as overpriced, so they probably had drastically reduced the percentage of Japanese equities in their portfolios compared to their actual weight. When the bubble burst, because of the single factor of the weight of Japanese equities, many management firms ended up beating the market. So what value does this track record hold when assigning the management of international equities from a Japanese perspective, excluding Japan? And suppose there is an asset management firm that operates globally: for Japanese clients, it manages international equities from a Japanese perspective, and for US clients, it manages international equities from a US perspective. In this case, it would be quite common that one beats the market while the other loses. For example, when the stock selection of US equities doesn’t go well, the results would differ significantly depending on whether those stocks are included in the portfolio. Such odd situations in international equities would not occur with global equities. There is only one global category, so they can be compared consistently. Although this is a technical point, it is also one advantage of global equities.

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The Fate of the Japan Atomic Power Company

Jun 18, 2018
byNoriyuki Morimoto

The Japan Atomic Power Company (JAPC) is the entity that started the first commercial nuclear power generation in Japan with Tokai Power Station in 1966. This station ended its operation in 1998 and is now in the process of decommissioning. JAPC’s Tsuruga Power Station Unit 1 also stopped operation last year and is due to be decommissioned as well. Currently, JAPC still operates the Tokai No.2 Power Station and Tsuruga Power Station Unit 2. But as the Nuclear Regulation Authority (NRA) identified an active fault line beneath Tsuruga Power Station Unit 2, it is virtually inevitable for it to be decommissioned. If JAPC could operate just one nuclear reactor (if it can be restarted) while having to decommission three, it may be too much pressure for the company even to survive. For Japan’s nuclear power industry, whether the business is to keep going or not, decommissioning technology is going to be vitally important going forward. In that sense, JAPC’s history as pioneer of both starting and ending nuclear power generation is a valuable one. Therefore, the company’s experience and skills as a group of technical experts have to be maintained. Even if the Japanese people choose to phase out nuclear power generation, it would take an extremely long time to complete the process. In order to phase out safely and to rationalize costs, a high level of nuclear technology has to be maintained and developed as a political agenda. Moreover, in theory, the government’s nuclear power policies should have settled with keeping nuclear power generation: the NRA, a government agency, is very active in enhancing safety of nuclear power generation and the healthy development of the nuclear power industry. Such activities would be an unacceptable waste in the direction of nuclear phase-out. Under the new regulatory standards of NRA, there will be a huge amount of additional cost including major refurbishing expenses. Such additional costs would ultimately be funded by the citizens, in form of utility fees or tax. If Japan was to phase out nuclear power after such a burden, it would be a tremendous waste.It the policy is to go toward nuclear phase-out, the NRA would have to focus its purpose strictly on safe decommissioning measures. And even in that case, the agenda of maintaining and developing advanced nuclear technology cannot be crossed out. 

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Are Japan's Power Companies Actually With Negative Equity?

Jun 04, 2018
byNoriyuki Morimoto

An asset is an asset because there is value in using it. If there is zero possibility for it to be used any more, it is no longer an asset but a lump of waste. So, accounting-wise, you have to book an impairment loss for its total book value. Supposing that the Japanese people choose to phase out nuclear power generation as early as possible, and all nuclear power stations are to permanently discontinue operations, the power companies that own nuclear power businesses would have to book huge amounts of impairment losses. This would cause the companies a negative equity, which makes it extremely difficult for them to procure funds, putting stable power supply at risk. In addition, something that has turned into waste is not only retired in accounting books but also physically. The process of physically retiring facilities requires costs, which have to be booked in advance as losses on retirement. A more serious issue is that no one can tell what the costs needed to retire the facilities would amount to, given that you are scrapping a nuclear power station. If such costs are estimated conservatively and booked in advance, power companies are sure to have a negative equity. Of course, policy measure can be taken to address such situations, such as introducing a special accounting treatment. But that doesn’t keep the companies’ equities from virtually turning negative. If power companies with huge liabilities end up having negative equity, that would be an emergency: much confusion and tremendous social costs should arise in the course of protecting stable power supply. It would at least become a hard question from a financial perspective: the financial industry would be facing problems. If problems are expected from the beginning, they should be prevented from a long-term perspective. This means that phasing out nuclear power has to be a thorough long-term strategy that includes detailed, technical discussions on account processing. Phasing out nuclear power is essentially a matter of decision by the people, so once it is decided it may as well go forward. But the practical procedures of achieving a nuclear phase-out is another issue. In any case, it would take time and money. Setting a shorter timeline would probably add to the overall cost. Therefore, it is certain that a rational timeline has to be set based on a rational estimate of costs to take planned steps in phasing out nuclear power.

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The Significance of Housing Allowances in Japan

May 21, 2018
byNoriyuki Morimoto

In Japan, there used to be apartments built exclusively for government employees. They tended to be well built structures in attractive locations, with disproportionately low rents, making them a benefit in kind with huge advantages. Apartments for government employees were probably established due to the nature of the bureaucrats’ job, which frequently required the person to move to any part of Japan, as well as housing conditions in the past. But they seem to have had a stronger aspect as a symbol of the bureaucrat’s privileged status. Company housing apparently had a similar background, together with the aspect of the company offering special treatment to its employees. But since the number of people to which a company can provide housing is limited, the need to adjust for the unfair allocation gave rise for housing allowances, as well as companies systematically leasing apartment complexes for their employees. It should not be overlooked that benefits in kind, like company housing, have a tax advantage. Housing allowances are a part of taxed income, but the difference in the lower rates of company housing compared to market rates is not subject to tax. Companies must also have had the intention to correct unfairness resulting from employees’ relocation. The system might have been a representation of the company’s will to treat employees fairly. For example, if an employee was assigned to a job in Hokkaido, companies often used to provide a “cold climate allowance”. Heating was initially provided by wood, which then shifted to coal, so the allowance was also called “coal allowance”. The cost for coal was an additional expense resulting from the relocation to a cold area, so at that time, it made sense to companies to compensate. In the past when cooling appliances were not available, heating expenses for cold areas stood out as additional cost. But things have changed. Cold areas have the advantage of needing less cost for cooling, and after all, the cost for living in a rural area is relatively low. In organizations with nation-wide operations and headquarters in Tokyo, as with government agencies, compensations are set based on Tokyo standards, so employees outside of Tokyo have a large benefit from the difference in living costs. Since companies can no longer deliberate on the indeterminable question of whether that is fair or unfair, they decided to abolish all kinds of allowances. 

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The Significance of Family Allowances in Japan

May 07, 2018
byNoriyuki Morimoto

Until quite recently, it was usual practice for Japanese corporations to provide family allowances. An employee with a spouse would receive a spouse allowance, and monthly payments were made for each child of an employee as child allowance. Family allowances are not paid in accordance to the employee’s achievements or labor. They do not compensate for anything, so it doesn’t make sense from the logic of corporate governance. Then why did family allowances continue in Japan as an element of the human resources system? Actually, to say that monetary payments always have to compensate for some specific effect is narrow-minded. People give and receive money in various social occasions like celebrations and as thank-you gifts. Such payments are made for the purpose of conveying some kind of feeling. It is also possible for a company to pay money to convey a sense of appreciation. So what were companies trying to convey through family allowances? It would not make sense for companies to provide allowances based on one’s family structure, which is unrelated to the company, unless they are based on the belief that members of a company share a certain value, history and culture, and together make something like a community. In other words, companies probably held the view that those inside were different from the people outside the company. Currently, it has become the norm for companies to pay essentially the same amount for the same work, whether or not it is done by a regular employee. But in the past, it was normal for regular employees to have an advantage. The compensation gap can be justified only as a naturally (rather than logically) established privilege of a person inside the company. In essence, family allowances were probably a way to build a sense of unity or belonging. In that aspect, there was something they intended to convey, as money works as a message.

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Surume Finance in Japan

Apr 23, 2018
byNoriyuki Morimoto

Surume is dried squid that is commonly enjoyed as a snack to accompany alcohol in Japan. Its texture is like hard chewing gum, and it’s said that you get more flavor as you keep chewing it. A company is a living thing that swims vigorously like a live squid. However, the company shown in numbers on financial statements is just one expression of behavior in the past, which can be likened to a dead, dry squid. According to the Japan Financial Services Agency (FSA), Japanese banks finance dead surume instead of live squid. The FSA refers to the live behavior of companies as business feasibility, and is telling the banks to make financing decisions based on its evaluation. On the flip side, the FSA holds the view that banks cannot carry out their true financial role if they depend on static criteria such as historical financial statements, availability of collateral, collateral value, and availability of guarantors. To give a concrete example, companies that have been making losses for the last several years, or lack sufficient equity capital because of business fluctuations, may struggle to obtain financing from a bank. But the social role of finance is precisely to support companies through these situations. The FSA is saying that banks should base financing decisions not on the companies’ static snapshots, but on their future potential of actively expanding business, by evaluating the inner aspects of companies. But one question is whether a bank, essentially an outsider, is capable of doing something like that. It’s true that you can’t learn the behavior of live squid from surume. But observing a swimming squid is not enough to obtain necessary information to make financing decisions. You also have to dissect dead squid and dry it into surume to analyze its components. While true financing is unlikely to take place without the willingness to swim together with live squid, that is not possible for a bank in practical terms. After all, the FSA is simply reminding the banks that surume used to be live squid.

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Rebuilding the Lost Myth in Japan

Apr 10, 2018
byNoriyuki Morimoto

Once upon a time, a farmer at his deathbed told his lazy sons that there was treasure hidden somewhere in his vineyard. After his death, the sons dug up the entire vineyard but could not find anything. Instead, they had a great harvest. Above is the well-known Aesop Fable called The Farmer and His Sons? The moral is that hard work itself is a treasure. This fable is quoted by philosophers including Georg Simmel and Walter Benjamin as having a deep significance. The philosophical point of discussion is that the sons took the farmer’s lie as a fact: a historical truth without any room for doubt, and this was supported by the father’s authority that let a lie pass as truth. Every ethnic group has its own myths of origin and traditional tales. While a lot of the myth may be high-flying fantasy, the ethnic members more or less have faith in it. In other words, the scope of which the myth holds some authority defines the scope of ethnic groups, in the same way that believing in the farmer’s lie made his sons his sons after all. Companies also have what are called myths of origin, traditions, cultures, beliefs, or philosophies. This is not the personal conviction of the founder or management, but something that grew out of it to be shared by the organization, breathed like air, believed in, and becoming a natural discipline of the members of the organization. This may be the myth around past success, but also becomes a driving force for the company’s future growth. In the past, Japanese companies often had a more or less religious kind of atmosphere, singing company songs and chanting corporate philosophies like dedicating an ode. But the myth has long been lost. How can this myth be rebuilt? We can’t just get employees to sing the company songs as a ritual again. Take the myth of technological strength: we see various projects in which small companies with high processing technologies take on difficult tasks, and attract much public attention when they succeed. But such projects do not hold much economic rationale. The intention here is to foster the belief in technological strength to the level of a myth. Commissioner Mori of the Japan Financial Services Agency is also putting effort in creating a myth in the finance industry. “Creation of shared value with the customer” is a myth. Financial institutions should hold the conviction that they would benefit not from pursuing their own profits but from taking action for the customers’ benefit. In that sense, this is a myth they have to believe in.

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Cultural Differences between US and Japan as Seen in Mortgage Loans

Mar 26, 2018
byNoriyuki Morimoto

When you take out a mortgage with a fixed rate, you either gain or lose depending on the change in interest rates. You lose when interest rates go down, and gain when they go up. But in theory, based on rational expectations in the entire market, the losses and gains should be equal: this is a hypothesis delivered on the premise that they have to be equal in order for the market principle to work. Asking whether or not a theory works out in a market is the same as asking whether the market is efficient. Efficiency probably depends on the rational regulatory environment, rather than the level of freedom in transactions (i.e. having less regulations), as well as how financial thought is grounded in daily practice, rather than sensibility of participants (i.e. how rational they are), so it is interesting to observe the structural differences of the US and Japanese mortgage markets. If a fixed-rate mortgage loan can be refinanced without fees at any given timing, a drop in interest rates will accelerate refinancing at lower mortgage rates. The US market is that type of market. In other words, the debtor has an advantageous right, called an option in financial theory, to refinance at a lower rate. Since everything has a price in theory, debtors are paying for this option as well: usually in the form of a higher mortgage rate. Thus the values of mortgage loans that can be refinanced and those that cannot are made equivalent through option fees. With mortgage loans that basically don’t allow refinancing, but can be made refinancable with an additional payment of fees, the theoretical value of such fees can be calculated through this equivalence. In the US mortgage market, the price of a refinancing option is thought to be at a point close to its theoretical value. While a highly advanced calculation method is needed to provide this theoretical value, in the US, the most advanced mathematics are applied in the mortgage market, which is very close to the lives of ordinary people. On the other hand, what about the Japanese mortgage market? For example, is the actual level of refinancing fees close to its theoretical value? The gap is probably bigger in Japan, with the stiff structure of bank fees and overcompetition of mortgage services. In other words, the Japanese mortgage market may not be so efficient.

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Japanese Mega Banks Don’t Understand Taste

Mar 12, 2018
byNoriyuki Morimoto

The Principles for an Effective Risk Appetite Framework, announced by the Financial Stability Board on November 2013, is a management framework that sets out elements of a financial institution’s healthy risk appetite, including risks they should willingly accept in order to achieve their business objectives. According to the Financial Services Agency, the framework features “risk appetite” as the aggregate level and types of risk that a financial institution is willing to accept in order to achieve its business objectives, based on business models specific to each institution. It is intended to be used as an internal common language to manage overall risk-taking policies, including capital allocation and maximization of profits. Japanese megabanks have also formed what should be their risk appetite frameworks and disclosed summarized versions of them, but without any specific description of risks they would willingly accept. They have only written down the structures in which they manage risks they actually take in a passive manner. What triggered the implementation of risk appetite frameworks was the lesson learned from the global financial crisis of 2008. Apparently, one cause of the crisis recognized by regulatory authorities was the management practices of major financial groups: their pursuit of profit without strategic objectives, which led them to lose sight of the finance industry’s role in society and to fail to fulfill their responsibility towards their customers. In other words, financial institutions had decided on which risks to accept from the viewpoint of putting profit above all. Consequently, financial institutions have since been required to reestablish their specific business models and redefine risks they willingly accept. This is an initiative for financial institutions to increase corporate value in the mid- to long-term, as a priority over pursuing short-term profits. Given that megabanks select the risks they willingly accept based on their specific business models, their healthy sensibility for risks is being tested here. When you liken that sensibility to taste, the cause of the financial crisis may be described as an overwhelming urge to relieve hunger: to pursue profits regardless of taste. In the risk appetite framework, institutions are expected to take sensible risks according to their own sophisticated taste cultivated in their culture. So there is supposed to be a shift from the tasteless pursuit of profit to tasteful creation of value, but can’t the megabanks tell good taste from bad?

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The Origin of the Myth that Japanese Prefer Savings to Insurance

Feb 26, 2018
byNoriyuki Morimoto

Insurance companies are strictly defined as companies that run insurance businesses by regulation, so they cannot handle savings products that don’t have an aspect of insurance. Therefore, they created savings-type insurance products that bundle savings products with insurance. This is how endowment insurance originated.   Funds for Japan’s post-war economic growth were based on the accumulation of small amounts of individual savings. Insurance companies played an important role in absorbing such small savings efficiently, using endowment insurance as a core product. However, by around 1980, the economy shifted to a slow-growth phase, and the social need for accumulating savings went into a decline.   As the economy matured, the social function of insurance shifted from savings to death security. Insurance companies rapidly increased the portion of death security, setting the life insurance payment at 10 times, then 20, 30, and 40 times that of maturity proceeds. This is how they started offering endowment insurance with term policies. The 40 times difference makes the insurance portion the outstanding component over the savings function. The central role of the product actually became insurance.   Then, why did the savings aspect still remain? One factor may be that the products were developed as an advanced version of endowment insurance. However, the more important factor is probably the profit gained from interest margins. In the financial environment at the time, insurance companies were generating investment profits above the promised interest rates, which they actively returned to the customers as dividends. The attractiveness of expected dividends played an important role in selling insurance products.   On the other hand, there was a theory that said Japanese people like savings and dislike insurance without maturity proceedings. According to this theory, since savings is a Japanese cultural preference, pure death security without maturity proceedings do not sell, so insurance providers had no choice but to bundle the savings aspect in their products.   However, I suspect that this theory was a myth created by insurance companies as a sales policy to sell savings products.

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Philosophers of Investment Should Reside in This Area in Tokyo

Feb 13, 2018
byNoriyuki Morimoto

Jimbocho is a district in central Tokyo. It is just north of Otemachi, a beautiful area with many high-rise office buildings facing the imperial palace: scenery that can be proudly presented to the world. No wonder that it fetches the highest rents in Tokyo. Meanwhile, Jimbocho is known for streets full of used bookstores. It looks like the type of commercial district that exists all over Japan: many small, low buildings remain in the area, with only a few large office buildings. However, the district is in central Tokyo all the same, offering very convenient transportation, including access to subway lines. Moreover, or despite of those facts, rents are low: not in absolute terms, but relative to the value it offers. How can that be said? Starting from Otemachi and heading north to and beyond Jimbocho, the farther you go from the center of Tokyo, the lower rents become. But the decline is not directly proportional to the distance. While there is a large gap in the rents in Otemachi and Jimbocho, the decline is much smaller even if you go much farther up north from Jimbocho. When you depict the changes in a graph, a steep cliff appears between Otemachi and Jimbocho, and from the bottom of the cliff, there is only a gradual downward slope. While Otemachi and Jimbocho have little difference in terms of convenience, rents are much lower in the latter. Farther up north from Jimbocho, while rents do not differ much, the level of convenience declines dramatically. Therefore, judging from the relation of price and quality, we can say that Jimbocho is a bargain?high quality and low price?as opposed to the area north of Jimbocho, where lower prices only match the quality of what you get. The basics of investment is to grasp the value of what you invest in: to find what is underpriced. A company that runs an investment business should follow that principle and base itself in such a location. That’s why our office is located in Jimbocho.

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A Price-less Rarity of a Book

Jan 29, 2018
byNoriyuki Morimoto

Books with historic value, an extremely small number of existing volumes, and very low chances of being found in used bookstores are classified as rare books. Whenever they happen to appear on the market, they are likely to be traded at extremely high prices?or are they? There is a book written by Takashi Negishi, a renowned economist and honorary professor of the University of Tokyo who was awarded the Order of Culture, titled The Time Tunnel of Economics (1984). This is an exciting collection of reviews on 24 selected classic works in economics, although the book itself is not rare. One of the books introduced in the above book is “seldom found in the lists of used bookstores, and doesn’t fetch a price because the volume is so rare”. It is Hiroshi Kawaguchi’s Study on Keynesian Economics (1953). Dr. Negishi described this book as “one of the earliest works in Japan featuring a full-fledged academic study on Keynesian economics: it is not only a good guide with excellent interpretations, but one of the best in terms of raising questions,” adding “I think I have been affected greatly by this book, at least at a subconscious level”. Since it was such a good book, a new edition was published in 1999 after Dr. Negishi wrote about it. Becoming a rare book means there is a strong demand for it among economic scholars, so from the publisher’s point of view, a new edition likely had prospects to sell. When a new edition is published, it seems that the price of the original edition is likely to fall, but what actually happens is not clear. As Dr. Negishi mentions, it is so rare that the book isn’t even properly priced. Put simply, without a book there is no transaction, without a transaction there is no price, and without a price, there is no way of knowing the price changes. Actually, I am the owner of this extremely rare Study on Keynesian Economics. I didn’t buy it expensively: instead I picked it up very cheaply from a box in which the used bookstore had thrown all kinds of worthless books. It was a moment of joy and excitement as a book lover. When Dr. Negishi says the book is so rare that it doesn’t fetch a price, it is only a presumption to interpret it as being extremely expensive. The reality of being price-less may be that it is totally forgotten and therefore available for almost nothing.

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