The "Survival Rules" for Japanese Banks, Insurance, and Fund Industry in the Low-Interest Rate Era

Abstract

Marked by the collapse of the Japanese stock and real estate markets in 1991, Japan has been in a 30-year economic stagnation. Compared to other countries in East Asia, Japan was the first to enter the era of low interest rates, similar to the current situation in China where bond yields are in a downward cycle. Therefore, this article aims to review the entire process from the emergence to the collapse of the Japanese economic bubble, and to analyze how the asset management industry coped and developed in the "Lost 30 Years" period under a low or even negative interest rate economic environment, providing insights for investors.

Challenges and Responses of Japanese Asset Management Institutions:

• Bank Wealth Management Departments: After the bubble burst, under the main bank system, banks continued to accumulate loans, leading to the formation of non-performing assets. With the narrowing of interest rate differentials in the low interest rate policy and losses caused by non-performing loans, the Japanese banking industry faced a bankruptcy crisis. To cope with the industry's winter under low interest rates, Japanese bank wealth management departments implemented a series of strategies in fund allocation. 1) Adjusting the asset structure, raising lending standards, and tightening loan sizes; 2) Increasing allocation of valuable securities internally and seeking high-yield assets externally; 3) Adjusting bond durations based on risk exposure and monetary policy, and engaging in alternative investments. In addition to improving fund allocation strategies, Japanese bank wealth management departments also vigorously developed other businesses, improving service models by expanding non-interest businesses to increase income sources and developing the modern elderly care industry to reform financial service models.

• Insurance Asset Management Institutions: On one hand, under the process of marketization and liberalization, insurance companies relied on high-interest policies and low premiums to compete for market share. On the other hand, in a low interest rate environment, investment mistakes by Japanese insurers led to severe losses, with pressure on interest spreads and insurers falling into a liquidity trap. Under the double blow to assets and liabilities, the insurance industry saw multiple bankruptcies, loss of public confidence leading to a wave of policy surrenders, and insurers caught in a vicious cycle of adverse selection. In the low-yield environment, Japanese insurance asset allocation strategies showed clear trends: 1) Funds concentrated on valuable securities with an enhanced risk aversion tendency; 2) More conservative allocation styles due to underweight pressure on the liability side, preferring low-risk fixed income products and extending the duration of government bonds to increase returns; 3) Increased holdings of overseas securities, mainly investing in foreign debt. At the same time, Japanese insurers explored in products, channels, and strategies, implementing a series of transformation measures: 1) Ceasing the sale of high-interest rate products and adjusting product yields to match the market; 2) Adapting product structures to the aging population, introducing various protection-type products, with individual insurance contributing more to income; 3) Transforming product sales channels to reduce costs, increase efficiency, and meet diverse customer needs.

• Investment Trust Funds: The growth of Japan's trust business mainly relied on the expansion of asset management-type businesses, which experienced contraction and fluctuations due to the collapse of the stock and real estate markets. In the decades after the bubble burst, Japan's investment trust industry achieved structural development through various arrangements: 1) Shifting fund allocation from equities to fixed income; 2) Increasing holdings of government bonds and overseas securities, with foreign securities mainly focused on bonds for a long period of time. In addition to the shift in fund allocation strategies, the Japanese trust industry sought development through product innovation and cost reduction: 1) Asset flow trust business emerged, shifting from primarily loan trusts to diversified development in trust business types; 1. Develop pension investment based on the trend of population aging, and create a new format of monthly settlement products; 2. With the expansion of ETF by the Bank of Japan, actively develop index funds; 3. Operate with low costs on the expense side, adjust the fee rate structure on the income side, lower management fees and commissions to compensate for product returns, and enhance product attractiveness; 4. Transform the sales channel structure to be more diversified, and expand the trust product market; 5. The product information disclosure mechanism is becoming stricter, and the level of investor protection is increasing.

In summary, in order to alleviate the super inflation brought about by the prosperous economic development stage, since the late 1980s, the Bank of Japan has started to cool down the economy, burst the asset price bubble, and then lowered interest rates through measures such as reducing bank deposit and loan interest rates, implementing quantitative easing, etc., to rescue the market. Japan has thus entered a low-interest rate era for nearly 30 years. In the long-term low-yield environment, the Japanese asset management industry has explored a series of measures based on its own asset-liability structure, business model, and other characteristics. The banking wealth management departments in Japan have adjusted the asset side structure, increased allocation of bonds and other valuable securities internally, sought high-yield assets externally, expanded non-interest business through alternative investments, developed the elderly care industry, and other means to improve income; insurance asset management institutions have increased allocation of valuable securities, lengthened the duration of domestic bonds internally, increased holdings of overseas bonds externally, to increase returns while ensuring risk hedging, and relied on lowering product preset interest rates, product structure and channel transformation to reduce costs and increase efficiency; investment trust funds have shifted fund allocation towards fixed-income products, increased holdings of overseas securities, diversified trust types, developed asset flow trust businesses, index funds, and through means such as opening up monthly settlement product formats preferred by the elderly, reducing fees and commissions, strengthening supervision, to enhance the attractiveness of trust products.

Risk Warning: Data statistics omissions, differences in financial systems and asset management industries in different countries; limitations of macro environments in different eras.

Main Text

• [Overview of the Low-Interest Rate Era in Japan]

Marked by the collapse of the Japanese stock and real estate markets in 1991, Japan entered a 30-year period of economic stagnation. Compared to other countries in East Asia, Japan was the first to enter the era of low interest rates, which bears some similarity to the current situation in China where bond yields are entering a downward cycle. Therefore, this article aims to review the relevant economic performance from the creation to the collapse of the Japanese economic bubble, and to outline the responses and developments of the asset management industry during the "Lost 30 Years" in a low or even negative interest rate economic environment, providing reference for investors.

1. Macroeconomic Trends

After over 30 years of prosperous development, the Japanese economy once fell into a stagnant state. Since the 1960s, under the "National Income Doubling Plan," the Japanese economy developed rapidly, with nominal GDP growth exceeding 10% for 19 consecutive years. From 1961 to 1991, the average annual growth rate was as high as 11.63%, and the nominal GDP soared to 469.42 trillion yen, nearly 23 times higher than in the early 1960s. Along with the economic prosperity came high growth in price levels. By the end of 1974, the CPI and GDP deflator growth rates reached as high as 23.22% and 20.81%, respectively, while the PPI growth rate also remained around 30% in the 1970s for a long period The obvious rise in prices has led to a galloping type of inflation in the Japanese economy, with economic bubbles gradually accumulating. Since the late 1980s, under a series of cooling policies by the Bank of Japan, economic activities in Japan have stagnated, with individual years even experiencing negative economic growth, at times entering a phase of high volatility, low inflation, and even deflation.

The overheated economy has given rise to the emergence and expansion of asset price bubbles, while the bursting of bubbles in the stock and real estate markets has led to a significant evaporation of funds and severe economic turbulence. In the 10 years following the bursting of the asset price bubble, the real housing price index in Japan fell from its peak of 165.79 in 1991 to 120.13 by the end of 2001, a decline of 28%, and the Tokyo Nikkei 225 index fell by over 50%. Since the beginning of the 21st century, the real estate market has remained in a prolonged period of low-level fluctuations, and the stock market, affected by external shocks, has also performed poorly.

In a sluggish employment environment, demand continues to be weak, further exacerbating the downturn in the economic outlook due to the deterioration of the supply-demand environment. After the economic bubble burst, the labor participation situation in Japan continued to deteriorate, with the unemployment rate exceeding more than twice that of 10 years ago by the early 21st century, peaking at over 5%. High unemployment rates were accompanied by stagnant growth in residents' disposable income and a lack of effective demand, leading to supply-demand imbalances and overcapacity, further exacerbating the vicious cycle of deteriorating corporate operating conditions.

Economic Downturn Overlapping with "Silver Economy" Development, Household and Corporate Sector Leverage Ratios Peaking and Falling, Government Social Security Gap Deepening Japan's Fiscal Burden. With the opening of the economic downturn cycle and the shift in market supply and demand relationships, in order to avoid exacerbating financial difficulties, residents and non-financial corporate sectors have successively reduced their debt risk exposure, leading to the phenomenon of "balance sheet recession" where leverage ratios gradually peak and fall, restraining the endogenous dynamics of the economy. At the same time, Japan's aging population process has not only caused labor shortages and reduced productivity, but also increased the rigid demand for pensions, leading to the continuous expansion of the social security fund gap, exacerbating the government's fiscal burden. According to available statistical data since 1997, Japan's government sector leverage ratio has continued to soar, reaching 228.6% as of 2020, about 2.8 times that of 1997, with the debt burden continuously increasing and the central fiscal deficit rate persistently maintained at a high level.

2. Capital Market Performance

Central Bank Market Rescue Initiates Japan's Low Interest Rate Era, Market Rates Gradually Decline. On the one hand, the Bank of Japan began lowering interest rates to rescue the market from July 1991, gradually reducing bank deposit and loan interest rates, and later implementing various quantitative easing policies. By the 21st century, Japan's bank deposit interest rates were less than 1%, and the central loan-to-deposit interest rate spread gradually decreased to around 1%. On the other hand, after the stock market bubble burst, the overall market demand for safe-haven assets increased, and the lowering of bank deposit and loan interest rates also raised market expectations for continued interest rate cuts, leading to a significant decline in government bond yields. On July 27, 2016, the 10-year government bond yield once fell to a record low of -0.297%

Low inflation combined with interest rate cuts have led to a consistent decline in both short and long-term interest rates in Japan, flattening the yield curve. Amid the increasingly sluggish inflation levels and financing environment, the increased demand for long-duration bonds has driven down long-term interest rates on Japanese government bonds, gradually narrowing the term premium, even leading to an inversion between 1989 and 1991. Since the implementation of loose monetary policy in 1991, the downward space for short-term interest rates has opened up, with interest rates for different maturities continuously declining, and term premiums have been oscillating and converging since the mid-1990s.

Under the main bank system, the Japanese bond market is dominated by government bonds, with an imbalanced variety structure and limited supply of high-yield bonds. Under the main bank system, Japan has implemented an integrated development model of "financial capital - industrial capital - commercial capital," where banks have long-term cooperative relationships with related companies, providing long-term low-interest loans to enterprises. Japanese corporate debt financing relies more on bank loans, resulting in lower demand for capital market financing. In addition, since the 1990s, the deleveraging intentions of the real economy sector have increased, leading to a continuous shrinkage in the size of credit bonds. As of the end of 2010, the outstanding amount of central and local government debt in Japan reached 797.33 trillion yen, accounting for 83.88%, with national bonds accounting for as high as 78.85%, while the balance of general corporate bonds accounted for only 6.50%. In terms of asset types, since the 2008 financial crisis, the effective yield of corporate bonds has widened, except for AAA-rated bonds, all other corporate bonds have maintained positive yields even after the era of negative interest rates began in 2016. However, at the same time, the sizes of corporate bonds, asset-backed securities, convertible bonds, financial bonds, and other varieties have been continuously shrinking. Due to the limitations of the bond supply structure, the application of credit downgrade strategies is restricted.

The dominant trend of global interest rate decline continues, with sustained overseas bond yield differentials. Since the 1990s, interest rates in various countries around the world have mostly shown a downward trend. However, when compared horizontally, whether with developed countries or emerging markets, Japan's government bond yields have always remained low for the same period. Especially since entering the era of negative interest rates in 2016, the yield differentials of emerging markets have become significant.

3. Performance of Household Financial Asset Allocation

Japanese households have a low risk appetite and tend to have a conservative asset allocation. Against the backdrop of deteriorating employment conditions and financial system instability, Japanese households, lacking a sense of security, tend to increase deposits, reduce leverage, repair the asset-liability situation of the household sector, with the cash and deposit allocation ratio remaining around 50% in the long term. In terms of financial management, households prefer to invest in insurance products, while the allocation to securities products has always been relatively low. As of 2022, cash, deposits, insurance, pensions, and standardized guarantee plans account for over 80%, while securities investments only make up 15%.

• [Challenges and Responses of Japanese Asset Management Institutions]

1. Bank Wealth Management Departments: Adjusting Asset Structure and Expanding Business Services

After the bubble burst, non-performing loans in banks continued to accumulate. After the end of World War II, the Japanese government played a leading role in economic reconstruction and industrialization. In this special historical context, Japan formed a unique main bank system, with increasingly close relationships between banks and enterprises. Under the main bank system, banks held a large amount of shares of affiliated companies and provided fixed mortgage loan support to these companies. At the same time, due to incorrect expectations of benign growth in the stock and real estate markets, Japanese banks lent heavily to real estate companies and invested some of their own funds in stocks and real estate. Since the 1990s, the asset price bubble has burst, the repayment ability of household sectors has decreased, many companies that borrowed from banks using real estate and stocks as collateral have gone bankrupt, banks have been unable to recover loans, and non-performing assets have accumulated rapidly, with the highest non-performing loan ratio exceeding 8%

Under the low interest rate policy, the interest rate spread of the banking industry has narrowed, coupled with losses caused by non-performing loans, leading to a bankruptcy crisis in the Japanese banking industry. After the bubble crisis, the credit demand from enterprises and households was weak, making it difficult for the banking industry to achieve economies of scale in lending. Meanwhile, the Japanese government continuously lowered the benchmark interest rate after the bursting of the bubble, significantly reducing loan prices starting from the 1990s, leading to a continuous narrowing of the interest rate spread on bank deposits and loans. In 1990, the interest rate spread was 3.3%, but by 2017, it had dropped to 0.67%, squeezing the profit margins of banks. The substantial decline in the risk premium for loans also reduced the cost-effectiveness of bank lending. Under the dual pressure of operating stress and asset losses, the myth of "no bank bankruptcies" in Japan was shattered, and bank bankruptcy and restructuring events began to occur one after another. In 1988, the Japanese interim parliament enacted the "Financial Revitalization Law" and the "Early Soundness Law," planning for issues such as bank bankruptcies and non-performing loan disposal. Starting from 2001, the situation of non-performing loans in banks gradually began to improve.

To cope with the industry's winter under low interest rates, the wealth management departments of Japanese banks have formulated a series of strategies in fund allocation.

First, adjust the structure of the asset side, raise the lending business standards, and tighten the loan scale. In order to prevent the continuous increase of non-performing loans, Japanese banks have increased the prudence of loan approval, leading to a phenomenon of "reluctant lending." Between 1994 and 2004, the total bank loan balance in Japan decreased from over 470 trillion yen to less than 400 trillion yen. By industry, the loan balances in the manufacturing and real estate sectors have been in a long-term shrinking state, and the loan balance in the household sector also experienced negative growth in the 1990s. In terms of the size of borrowing enterprises, since the beginning of the 21st century, bank loans and discounts have mainly been provided to small businesses

Secondly, increase the allocation of valuable securities internally and seek high-yield assets externally. In an environment where net interest margins and loan-to-deposit interest spreads are narrowing, the banking industry's investments are mainly focused on increasing the allocation of government bonds, while there is a certain reduction in stocks and corporate bonds, gradually stabilizing at a lower scale. At the same time, to cope with the long-term low interest rate environment domestically, the banking industry actively increases the allocation of high-yield overseas securities, with the scale of overseas securities holdings continuously rising. As of the end of November 2023, over two-thirds of the total assets of the Japanese banking industry are allocated to government bonds and overseas securities, while the proportion of stock allocation is only 5.88%.

Thirdly, based on risk exposure and bond duration adjusted by monetary policy, engage in alternative investments. Since the beginning of the 21st century, Japanese banks have shown a tendency to shorten the duration of bonds. From 2001 to 2005, the duration of government bonds held by banks decreased by about 2 years, possibly due to considerations of avoiding long-term interest rate risks. After Japan implemented quantitative and qualitative easing (QQE) in 2013, banks gradually lengthened the duration, and according to related research, "banks will lengthen the duration to about 7-10 years." At the same time, since 2002, banks have continued to increase investments in alternative financial products such as structured products, credit investments, and hedge funds, but the overall allocation ratio is relatively low. As of 2006, the allocation ratios of alternative investment products for major banks and regional banks were only 3.7% and 4.5%, respectively

In addition to improving the capital allocation strategy, the wealth management department of Japanese banks is also vigorously developing other businesses to improve service models.

Expand non-interest businesses to increase sources of income. After the burst of the economic bubble, Japanese regulatory agencies relaxed business restrictions on financial institutions, encouraging banks to develop comprehensively. Commercial banks actively expand their business lines to increase non-interest income such as commissions, fees, and transaction fees. Taking Mitsubishi UFJ Financial Group (MUFG) as an example, since 2004, MUFG's non-interest income has fluctuated and risen, reaching 1.6954 trillion yen by 2023. Investment funds, securities, and credit card businesses contribute the most to non-interest income, accounting for over 40%.

Develop the modern elderly care industry and reform financial service models [7]. To adapt to the aging population, the government is guiding Japanese banks to establish a "Modern Elderly Care Industry Fund" in collaboration with other financial sectors to provide low-interest loans to the elderly care industry. They are also reforming financial service models by establishing corporate pensions, conducting various trust businesses such as chattel and monetary claims, gradually building a three-pillar pension system.

2. Insurance asset management institutions: Shift in investment strategies, transformation of product channels

On one hand, under the process of marketization and liberalization, insurance companies rely on high-interest policies and low premiums to compete for market share. Since the 1980s, Japanese market interest rates have been rising. With the support of comparative effects and optimistic market expectations, insurance companies have been competing to pursue business growth by increasing policy interest rates. The effective average policy interest rate of insurance companies once rose to 8% [8]. The signing of the Japan-US "Insurance Framework Agreement" in 1994 opened up the Japanese insurance market, leading to the influx of high-quality and low-cost foreign products. The "Financial Big Bang" in Japan in 1996 and the promulgation of the "New Insurance Business Law" further relaxed restrictions on interest rates and foreign investment, intensifying the competition in industry product returns. In addition, since Japan implemented the policy of liberalizing insurance rates in 1998, insurance companies have had to maintain market share by lowering premiums, putting pressure on the revenue side of new premium income for insurance companies

On the other hand, in a low interest rate environment, investment mistakes by Japanese insurers have led to severe losses, and interest spread losses continue to widen. In the late 1980s, Japanese insurance institutions invested heavily in stocks, real estate, and US dollar assets. Starting in the 1990s, as interest rates in the Japanese market continued to decline along with the Nikkei index, the market value of securities shrank, real estate prices plummeted, and US dollar assets shrank due to the depreciation of the US dollar, leading to huge losses on the asset side of insurers. Under the long-term low or even zero interest rate policy that followed, investment returns for insurers continued to decline, creating huge interest spread losses between the returns on sold products and the predetermined interest rates. Faced with the heavy burden of payout costs on maturing policies, insurers struggled to fulfill their obligations in full and on time, leading to rapid accumulation of non-performing assets and financial distress. Unlike the banking industry, under the "bank priority" main bank system, the Japanese government did not implement rescue measures for insurers at this stage, to some extent exacerbating the crisis in the insurance industry.

Under the dual impact on the asset side and liability side, bankruptcies in the insurance industry have been frequent, with loss of public confidence leading to a wave of policy surrenders, plunging insurers into a vicious cycle of adverse selection. Up to now, a total of 8 life insurance companies and 2 property insurance companies in Japan have gone bankrupt, with the main reasons being investment losses, asset depreciation, and interest spread losses. Defaults on policies and the significant reduction in predetermined interest rates for bankrupt insurers have dealt a heavy blow to public confidence, leading to a wave of policy surrenders by the public. The remaining high-interest rate policies have caused adverse selection, further worsening the situation of interest spread losses for insurers.

In the low-yield adversity, the investment allocation strategy of Japanese insurers shows clear trends, mainly in three aspects. First, funds are concentrated in securities with value. In a low-interest rate environment, insurance funds are more actively investing, with the share of securities investments increasing, while interbank borrowing, loans, and other asset shares are declining. In the early 1990s, the proportion of insurance funds allocated to securities was less than 50%, but by 2020, the allocation of securities by Japanese insurance funds reached ¥23.44 trillion, accounting for 74.22% of total assets. However, since the 2008 financial crisis, the proportion of insurance funds in deposits has also been on the rise.

Second, based on the pressure of under-allocation on the liability side, the allocation style is more conservative, preferring low-risk fixed-income products, and extending the duration of government bonds to increase returns. Learning from the historical lessons of the interest rate spread crisis in the 1990s, insurance companies are paying more attention to the prudence of fund allocation, increasing allocation to low-risk fixed-income products mainly composed of government bonds, followed by corporate bonds, local government bonds, with a particular extension of the duration of government bond investments. The proportion of stock allocation has decreased, with insurance companies allocating over 40% of securities investments to stocks in the early 1990s, but by 2022, the proportion of stock investments in total securities investments is less than 30%.

Third, increasing holdings of overseas securities, with a focus on investing in foreign debt. In the domestic environment where investment opportunities are generally lacking and overall asset returns are low, insurance companies have increased the proportion of investments in overseas securities to diversify risks and seek investment opportunities, with a focus on bond products. Taking life insurance as an example, in recent years, the proportion of bonds in overseas securities investments has been increasing year by year, with Japanese life insurance companies' overseas securities investments in bonds accounting for 95.7% by 2022.

Since the beginning of the 21st century, the central return on investment for Japanese life insurance companies has been around 2%, with stocks and overseas securities coexisting with high volatility and high returns, while bond, loan, and real estate investment returns have remained stable at relatively low levels. Overall, apart from a significant decline in 2008 due to the economic crisis, the investment return rate of the Japanese life insurance industry has generally revolved around a central return rate of 2%, showing strong volatility. Looking at the types of investment targets, the high volatility of returns mainly comes from domestic stock market investments and overseas securities investments, mainly due to the significant impact of these two types of targets on the global macroeconomy, often leading to increased returns during economic upturns During an economic downturn, the impact on the environment is significant. The return on stock investments has been rapidly increasing since 2019, reaching 12% by the end of 2022. Domestic bond investments, loans, and real estate investments have provided insurers with a stable and continuous basic income, effectively safeguarding the safety of insurance funds.

At the same time, Japanese insurers are exploring in terms of products, channels, and strategies, implementing a series of transformation measures.

They have stopped selling high-interest rate products and adjusted product yields to match the market downturn. During the bubble economy period, a large number of high fixed-rate products accumulated, putting severe pressure on the solvency of life insurance companies. To adjust and improve the interest rate spread situation, life insurance companies have continuously lowered the fixed interest rates. In the early 1990s, the average fixed interest rate for life insurance policies reached 5.75%, while by the early 21st century, the average fixed interest rate for life insurance had dropped to below 1.5%.

They are transforming product structures to match the aging population, launching various protection-type products, with individual insurance contributing more to the income side. With the continuous aging of the Japanese population, the demand for protection-type insurance products such as health insurance, medical insurance, and pension insurance among Japanese nationals is increasing. To cater to the changing demand side, insurers are actively adjusting their product structures, introducing a variety of insurance products to enrich customer product choices. Taking life insurance companies as an example, looking at the individual insurance outstanding balance, the Japanese life insurance market is mainly dominated by whole life insurance and term life insurance, with the proportion of both showing a continuous increase since 2014, while the scale of additional term life insurance and interest rate-linked savings life insurance is gradually decreasing. From the premium income side, individual insurance contributes the most to insurers' income.

This is the translation of the content provided Product Sales Channel Transformation, Cost Reduction and Efficiency Improvement to Meet Diverse Customer Needs. With the development of the Internet era and the further refinement of social division of labor, the sales channels of insurance companies have gradually diversified. Taking life insurance companies as an example, since the 1990s, the proportion of product sales through the Internet and insurance agencies has been increasing year by year, with the percentage of insurance company personnel sales decreasing from nearly 90% in 1991 to 55.9% in 2021. The transformation and upgrading of sales channels not only helps insurance companies reduce labor costs and improve operational efficiency through communication technology, but also helps them leverage their channel advantages to meet diverse customer needs, enhance service quality, and personalize services.

3. Investment Trust Funds: Adjusting Allocation Strategies for Innovative Efficiency

In Japan, funds are referred to as securities investment trusts. Since the promulgation of the "Trust Law" and "Trust Business Law" in 1922, the trust business in Japan has been continuously improved. In a long-term low-interest rate environment, Japan has gradually adjusted its allocation strategies, enriched product types, and achieved certain structural development. As of now, the trust business in Japan has achieved full coverage in the civil and commercial fields.

The growth of the trust business in Japan mainly relies on the expansion of asset management business. Since the 1980s, the Japanese investment trust industry has experienced rapid development in asset price bubbles. In 1980, the net assets of trusts were only 6.05 trillion yen, but by 1989, it had expanded to 59.65 trillion yen. In the 1990s, with the bursting of the asset bubble and the impact of stock price plunges, trust product performance declined, leading to a large number of redemptions by investors and a contraction in the scale of the trust industry. In terms of business types, the trust business in Japan can mainly be divided into asset utilization trusts, asset management trusts, and asset securitization trusts. Asset utilization trusts refer to trusts actively managed by trustees, asset management trusts refer to trusts where trustees manage trust property based on the instructions of the settlor (i.e., transaction management trusts), and asset securitization trusts refer to trusts established to facilitate the securitization of assets, allowing the original beneficiaries to make financial adjustments and raise funds. In terms of entrusted scale, the scale of asset management trust business has expanded significantly. From 2001 to 2023, the scale of asset management trust business increased from 214.3 trillion yen to 1277.6 trillion yen, with an average annual growth rate exceeding 50%. Asset utilization and asset securitization trust business have continued to hover at low levels. Asset utilization business reached a peak of 159.5 trillion yen in 2006 but fell back to around 120 trillion yen due to factors such as the financial crisis, while asset securitization business has shown a growth trend, reaching 117 trillion yen by 2023, about 6 times the size in 2001. In addition, other types of trust businesses have appeared since 2008, but their scale remains relatively small

Affected by the sharp decline in the stock and real estate markets, the Japanese trust industry experienced a period of contraction and volatility. In 1990, the industry's operating profit and net income reached 375.4 billion yen and 209 billion yen respectively, but by 1995, they had dropped to -1.3944 trillion yen and -1.4039 trillion yen, with average annual declines of 391% and 313% over the past five years. The industry's overall performance severely declined, leading to significant losses.

Decades after the bursting of the bubble, the Japanese investment trust industry underwent structural development through a series of arrangements.

On one hand, fund allocation shifted from equities to fixed income. After the bursting of the stock market bubble, investors' risk appetite decreased, leading to a preference for lower-risk fixed income products in investment trust funds. The scale of stock investment trusts decreased while bond investment trusts increased. Since Japan began issuing MMFs (Money Market Funds) in 1992, the size of Japanese bond trusts exceeded that of stock investment trusts, with net asset value accounting for as high as 66.48% in the early 21st century. Starting from August 2000, due to the Bank of Japan's policy of zero interest rates on interbank lending, the attractiveness of MMFs decreased, causing a decline in the overall size of bond trusts. By 2002, the scale of stock-type trusts surpassed that of bond investment trusts, achieving significant growth.

On the other hand, increasing holdings of government bonds and overseas bonds. The Japanese trust industry tends to increase holdings of stable government bonds and seek opportunities in overseas markets, while relatively reducing investments in local government bonds, corporate bonds, and stocks. For a long time, the industry mainly focused on bond investments in overseas securities, with Japanese trust industry's overseas bond investments reaching 22.45 trillion yen by 2010, accounting for 73.8% of the total overseas investment during the same period Since 2011, overseas stock investments have been on the rise, surpassing overseas bond investments in 2020, reaching 11.69 trillion Japanese yen.

In addition to changes in fund allocation strategies, the Japanese trust industry is also seeking development through product innovation and cost reduction.

First, asset flow trust business is on the rise, and the types of trust business have shifted from primarily loan trusts to diversified development. Since the 1980s, a large amount of loan trust funds in Japan flowed into real estate and the stock market, resulting in a large number of non-performing debts after the bubble burst. Under the "Loan Trust Law" used at that time, there was pressure to guarantee principal and interest at maturity. Since the burst of the bubble economy, the scale of loan trusts has gradually decreased, and the scale of securities trusts also experienced a brief downward trend due to the impact of asset price plunges. To improve the risks of loan trust business and expand income sources, the trust industry began to carry out real estate asset securitization business based on its own experience in real estate valuation. With the joint efforts of the government and the industry, asset securitization trust business has been continuously enriched and improved, developing from the underlying real estate to various types of monetary debts such as lease rights, bill rights, and credit rights. During this period, the trust business landscape has also diversified, with the scale and proportion of trust, investment trust securities, pension trusts, and other businesses developing to a certain extent.

Second, based on the trend of aging population, pension investment is developed, and new monthly settlement product formats are created. The majority of income for elderly people after retirement comes from pensions, with a supplementary need for monthly cash flow. Based on the special preference of elderly clients for increasing short-term income, the Japanese trust industry has created monthly settlement trust products that distribute dividends monthly based on monthly net asset value. In the aging process in Japan, such products were once sought after by investors, with the scale expanding to 42.67 trillion yen in 2014. However, due to the fact that this model does not comply with the law of compound reinvestment and is not conducive to the accumulation of total investment returns, the scale has shrunk in recent years. Nevertheless, the central scale has remained at around 20 trillion yen in the past five years

Third, with the expansion of the Bank of Japan's ETF balance sheet, actively developing index funds. To help Japan's economy overcome deflation, Haruhiko Kuroda, Governor of the Bank of Japan, proposed QQE (Qualitative and Quantitative Ease) on top of the Comprehensive Monetary Easing (CME) policy after taking office in 2013. The central bank began massive purchases of ETFs. From 2013 to 2018, the Bank of Japan continued to increase its purchases of ETFs, with the amount increasing significantly from 11 trillion yen to 65 trillion yen, with an average annual growth rate of 48.7%. The central bank's expansion of the ETF balance sheet has helped marginally revive the Japanese stock market. Leveraging the policy timing of the central bank's ETF purchases, the trust industry began to vigorously develop passive investments and launched index funds. Over the decade from 2013 to 2023, the proportion of index funds in the public trust industry increased from 9.2% to 29.2%, with an average annual growth rate of 12.4%.

Fourth, operating with low cost on the expense side, adjusting the fee rate structure on the revenue side to compensate for product returns by reducing management fees and commissions, enhancing product attractiveness. In the period of bursting bubbles and low interest rates, to withstand market volatility and reduce business costs, Japanese trust banks (banks that are allowed to engage in trust business based on laws regarding financial institutions engaging in trust business, with trust business as their main business) have achieved cost reduction and efficiency improvement on the expense side by lowering regular expenses. Since 1990, Japanese trust banks have continuously reduced deposit interest rates in a low-interest-rate environment, reducing regular expense outlays. However, the level of management fees has remained relatively stable, with an average change rate from 1990 to 2022 of only -0.27%. At the same time, industry revenues have also been decreasing, with the largest decrease in loan interest, dropping from 2.83 trillion yen in 1990 to 0.55 trillion yen in 2022. Trust fees have also decreased from 595.1 billion yen in 1990 to 374.6 billion yen in 2002, mainly due to the trust industry lowering management fee rates and transaction commissions Fifth, the structural diversification transformation of sales channels, developing trust products to expand the market. In the past, Japanese trust products relied entirely on securities companies for sales, with a single sales channel. Since the 1990s, in a sluggish market environment, the Japanese government has implemented a series of diversified reform measures for trust product sales channels. In 1992, 1997, and 1998, it opened up direct sales channels for trust companies, with trust companies using bank and other financial institution counters for direct sales channels, as well as sales channels through banks, insurance, and other financial institutions. Since the 21st century, the proportion of sales by securities companies has gradually decreased to around 50%, while sales channels of banks and other financial institutions have rapidly expanded, maintaining a proportion of around 45% in recent years. In terms of product types, direct sales channels for trusts and bank sales channels mainly focus on selling equity trust products, while debt trust products rely more on sales through securities companies.

Sixth, the product information disclosure mechanism is becoming stricter, and investor protection efforts are increasing. Since 1998, Japan's trust industry has implemented a mandatory audit system, where trust companies are required to disclose trust asset balance sheets, income statements audited by external auditors, and annual reports in accordance with the Securities Exchange Act to protect investor interests and regulate industry development In order to alleviate the super inflation brought about by the economic prosperity and development stage, starting from the late 1980s, the Bank of Japan began to cool down the economy, burst the asset price bubble, and then lowered interest rates to rescue the market through measures such as lowering bank deposit and loan interest rates, implementing quantitative easing, etc. Japan thus entered a nearly 30-year era of low interest rates. In the long-term low-yield environment, the Japanese asset management industry, based on its own asset-liability structure, business model, and other characteristics, has explored a series of coping measures. The asset management departments of Japanese banks have adjusted their asset-side structures, increased allocations to bonds and other valuable securities internally, sought high-yield assets externally, expanded non-interest business through alternative investments, developed the elderly care industry, and other means to improve income; insurance asset management institutions have increased allocations to valuable securities, lengthened the duration of domestic bonds internally, increased holdings of overseas bonds externally, to increase returns while ensuring risk aversion, and reduced costs and increased efficiency by adjusting product preset interest rates, product structures, and channel transformation; investment trust funds have shifted fund allocations to fixed-income products, increased holdings of overseas securities, diversified trust types, developed asset flow trust businesses, index funds, and improved the attractiveness of trust products by opening monthly settlement products preferred by the elderly, reducing fees and commissions, strengthening supervision, etc.

Author: Yin Ruizhe (SAC Practitioner Certificate Number: S1450523120003), Li Yuze (SAC Practitioner Certificate Number: S1450523120004), Hu Yilin (SAC Practitioner Certificate Number: S1450524040005), Source: Ruizhe Fixed Income Research, Original Title: "Performance and Strategic Analysis of Japan's Low Interest Rate Period Asset Management Industry"