Toward a Sustainable Japan--Corporations at Work Article Series No.55
Changing Money Flow - Daiwa Asset Management Co.
http://www.daiwa-grp.jp/ir/english/corporate/index.cfm

The Significance of the Daiwa Eco Fund
In February 2006, Daiwa Securities Group introduced an investment trust called the "Daiwa Eco Fund," an example of socially responsible investing (SRI). The fund invests in "Eco2" companies, companies that are good both in terms of "economy" and "ecology", and making healthy profits while taking care of the environment.

SRI came on the Japanese radar in 1999, when Nikko Securities Co., a major securities firm, offered the Nikko Eco Fund. This popular fund was soon followed by other similar funds, and total assets of all those SRI funds grew rapidly to between 100 and 150 billion yen (about U.S.$850 million and $1.3 billion). This growth later plateaued, partly due to the long recession in Japan. It is in this context that, as of November 27, 2006, the Daiwa Eco Fund has accumulated 55.6 billion yen (about U.S.$470 million) in net assets, reflecting the keen interest in Japan for SRI.

An investment trust is a financial product wherein fund management experts invest large sums of money, collected from many individuals, into stocks and bonds and then manage the investments. In practice, there are three entities that work together as a team: (1) a securities firm or bank that sells the financial product, (2) an investment trust company that manages the money using its know-how, and (3) a trust bank that actually administers the fund. The Daiwa Asset Management Co. established and manages the Daiwa Eco Fund. A Daiwa Securities Group company, it has grown to become a leader in Japan's investment trust industry since its establishment in 1959.

The company has a total of 403 professional asset managers who have established and manage a wide variety of funds. Its five current SRI funds are the Daiwa SRI Fund, the Daiwa Eco Fund, as well as the Double Wing, Best Six, and OH Mirai funds. As a result, the net assets of Daiwa's various SRI products account for about 30 percent of all 30 Japanese SRI funds, which totaled 230 billion yen (about U.S.$2 billion) in net assets as of July 2006, according to Wikipedia.

Why is Daiwa Asset Management the leader in this field? Masaru Arai, Chief Investment Officer of the company, says, "Daiwa Securities Group has declared that the realization of a sustainable society is a corporate social responsibility, and on the basis of that thinking we have asked ourselves how we, as a financial institution, can contribute to sustainability. As a financial group engaged in the securities market, unlike banks and insurance companies, we consider that an investment trust is the most powerful means we have".

A Profoundly Changing Financial Business
SRI, which began in the West at the start of the 20th century, is now regaining attention. What underlies this comeback is a growing interest in stocks worldwide, as part of a shift from indirect financing, such as lending and liabilities, to direct financing such as stocks.

Also, as people become more aware of the importance of the relationship between money flow and global sustainability, new frameworks are being created for financial institutions to conduct themselves within.

These include the United Nations Environment Programme Finance Initiative (UNEP FI), which aims to pursue and disseminate the best environmental and sustainability practices at all levels of financial institution operations, and the Principles for Responsible Investment (PRI), which encourage institutional investors to give adequate consideration to the environment, society, and corporate governance in their investment-related decision-making processes. Daiwa Asset Management is the first Japanese investment trust company to become a signatory of the PRI. UNEP FI http://www.unepfi.org/ PRI http://www.unpri.org/

How does Japan fit in with these global trends? SRI began in the West, but Japanese businesses, mainly the manufacturing industries, have been sensitive to social responsibilities for a long time. Although there was a pause in the SRI movement nationally after Japanese eco-funds were first offered in 1999, spurred by environmental activities Japanese companies today are catching up with the global SRI trend.

An increasing number of Japanese companies are included in SRI indexes such as the FTSE4Good Index Series. One challenge they face, however, is how to convey clearly to the world what indicators they are reporting and why, taking into account the cultural differences with the West.

SRI Agenda (Part 1): Performance Evaluation

From the point of view of size, however, SRI funds make up only a small percentage of all Japanese investment trusts, which total tens of trillions of yen. What is necessary for SRI funds to be more widely accepted in the future?

"The greatest challenge is to verify that SRI funds perform", says Mr. Arai. The trading periods for investment trusts are short compared to those for pension funds and the like, and they are usually set based on an evaluation of financial indicators. Since general investors seek the highest economic returns, some people still argue that it can be disincentive to consider non-financial factors such as the environment or society.

Mr. Arai thinks that quantitative analysis is the key to overcoming this challenging situation. "SRI has come to be recognized as a long-term approach, but today the question is how it influences short-term performance. As financial management experts, we cannot simply say that an SRI fund also performs well. We must comprehensively analyze and validate as data the relevance of SRI evaluation items, various market factors, perspectives and pairings. Furthermore, we must indicate quantitatively what results will be achieved under what types of conditions. This is essential for SRI to be an established practice in the future."

One of Daiwa's efforts is a joint research project with the Graduate School of Economics, Kyoto University to develop models for evaluating intellectual property and intangible assets. It aims to establish a scheme to measure what cannot be measured by conventional financial analysis, including the value of corporate brand images. The creation of such analytical tools should lead to the quantitative evaluation of SRI funds.

SRI Agenda (Part 2): Communicating with Investors and NGOs

Another thing that must happen for SRI to be established in society is that it must spread to the general investor. The question of whether factors such as environment, social responsibility and governance contribute to short-term returns can be answered simply: if many investors invest with these factors in mind, the fund will increase in value. But in Japan, corporations are more enthusiastic about CSR than are investors, and the general investor has not shown much interest in SRI.

In the West, on the other hand, there are many investors who evaluate companies based on their CSR performance express their intention to not invest in poorly-performing companies. And there are non-governmental organizations (NGOs) that propose ideas to improve standards such as FTSE4Good Index. It is through such active communication between investors and corporations as well as between companies and non-profit organizations that awareness and standards for SRI can be enhanced.

Daiwa Asset Management annually has about 8,000 meetings with companies, including IR (Investor Relations) visits from companies. Mr. Arai says, "On those occasions we want to explain not just new and revised SRI indices but also the basic ideas behind them." The company also intends to create opportunities for companies to communicate and engage in dialogue with investors, civic organizations, and non-profit organizations.

Future Trends
How will money flow change from this point onward toward a sustainable society? "The rapid spread of CSR and SRI in Japan has occurred only in the last five or six years. We might be seeing bigger changes in the next five years," says Mr. Arai.

For example, what will the development of SRI in China be like? As Chinese companies grow, both foreign investment in China and Chinese investment abroad are on the rise. Naturally, foreign investors will increasingly demand higher standards for Chinese companies. As information sharing increases internationally, Chinese companies will soon catch up with these changes. It's possible that many of them will be among high-SRI-ranking companies five years from now.

In a world where SRI is the norm rather than a special product, environmental, social responsibility and governance standards would be applied to evaluate not only SRI funds but also ordinary investment trusts. We look forward to seeing further initiatives by Daiwa Securities Group, which incorporates social responsibility into the field of finance and considers solving problems according to the above principles to be its mission, as well as from Daiwa Asset Management, which is leading the way in the establishment and management of SRI.

(Staff Writer Kazunori Kobayashi)

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