Japan may have been late to the party on ESG investing. But, after a slow start, there is no doubt that asset managers and financial institutions have begun to embrace the importance of integrating ESG factors into investment decision-making. In fact, Prime Minister Fumio Kishida’s advocacy for a ‘new capitalism’, in which business helps to address social and environmental problems, underlines how Japanese financial actors have little choice but to take responsible investing seriously.

“ESG is now everywhere in Japan,” says Yuka Ogasawara, impact officer at SIIF, the Japan Social Innovation and Investment Foundation. She points to the role of the Government Pension Investment Fund, the world’s largest asset owner, in encouraging the Japanese market to consider ESG factors. GPIF’s announcement in 2015 that it would begin to integrate ESG considerations into its investment decisions was a “really big trigger” that helped to kickstart ESG investing in Japan, Ogasawara says.

With consideration of ESG factors increasingly widespread, Ogasawara believes that the time has come for Japan to take the next step. “The players in the ESG market are now starting to go beyond ESG and look towards impact,” she says.

Impact’s popularity grows

An indication that Japan’s financial sector is waking up to impact investing came in November last year, when 21 leading financial institutions – including MUFG Bank, the country’s largest – formed the Japan Impact-driven Financing Initiative. The initiative’s signatories committed to work together in growing the impact market and implementing new processes to measure and manage impact.

Japan’s financial heavyweights have undoubtedly spotted the signs that impact investing is growing in popularity. SIIF’s latest report finds that assets under management in impact investment in Japan grew by some 250 percent last year, reaching at least ¥1.3 trillion ($10 billion; €9.4 billion). The growth in impact investing is the result of both new players entering the impact investing space, and existing investors increasing their allocations to impact strategies.

“The players in the ESG market are now starting to go beyond ESG and look towards impact”

Yuka Ogasawara
Japan Social Innovation and Investment Foundation

Lucia Vancura, director, operations and global markets at Meros Consulting, which is advising a new agriculture-focused impact fund, tells Private Equity International that she is unsurprised by the jump in activity in the impact investment space. “We can just feel it. In the last 18 months to two years, there’s been a lot more interest – not necessarily specifically in impact investing, but ESG investing, sustainable investing, green bonds.”

The Japanese impact investing market is certainly not limited to dedicated impact vehicles. “There is increasing growth in Japan both of dedicated impact funds and more holistic integration of impact considerations into broader investment practice,” says Daniel Wiseman, head of Asia-Pacific policy at the UN’s Principles for Responsible Investment. “One of the key trends we are seeing in Japan and globally is that sustainability outcomes and impacts are also increasingly being factored into mainstream strategies and funds.”

While SIIF’s latest data clearly shows progress, the obvious flipside is that the total amount of AUM dedicated to impact remains relatively small. Just 31 organisations are active in impact investing in both public and private markets according to SIIF – although this does represent a sizeable increase from the 20 players recorded a year earlier.

Even proponents of impact investing are quick to caution that the Japanese market remains relatively small and immature. Vancura acknowledges that “awareness of the concept of impact investing is still very low, with many misconceptions or doubts that need to be addressed among Japanese investors”.

Ogasawara, meanwhile, estimates that the market for impact investing is around 10 years behind the US and UK. “Globally, around 15 percent of AUM invested in ESG funds is dedicated to impact,” she points out. “The figure is much lower in Japan, as the impact investing market is still in its infancy.”

Conservative mindset

A key challenge for Japanese managers attempting to fundraise for impact-focused vehicles is the risk aversion of the country’s asset owners. Sayaka Takatsuka, senior director in the impact investment team at Shinsei Corporate Investment, which manages the impact-focused Hataraku Fund in cooperation with SIIF and Mizuho Bank, notes that “pension funds are more conservative – not only to impact investing, but to equity investments in general, because they prefer to have a certain coupon every year. They tend to prefer more stable returns.”

Several of the larger Japanese pension funds have been reluctant to follow GPIF’s lead in embracing ESG, let alone starting to test the waters of impact investing.

“Whether pension funds start to prioritise impact really depends on the political climate,” says Ogasawara. “There has been a shift to consider ESG factors, but a focus on impact would require political backing.”

“Awareness of the concept of impact investing is still very low”

Lucia Vancura
Meros Consulting

She adds that the “refusal of pension funds to enter the impact investing market reflects differences in the interpretation of fiduciary duty, compared to Western countries”.

But there are some signs that Japanese investors will gradually become more willing to consider impact investing as a viable strategy, says Wiseman. “There is now widespread recognition that the pursuit of impacts that can help mitigate system-level ESG risks falls squarely within many institutional investors’ duties.

“Even for pension funds there is now a clear acknowledgment that ESG risks will inevitably impact global capital markets over the long term, and therefore a direct incentive to adopt investment and stewardship strategies that mitigate negative and maximise positive ESG impacts.”

Vancura points out that much of the reticence from asset owners can be explained by the reality that – with impact investment so nascent – managers have not yet had the chance to demonstrate a track record of impact while achieving healthy returns. Now, attitudes could be beginning to shift, she says. “People are willing to consider much more innovative investment opportunities recently… We’re seeing things that we didn’t see four or five years ago.”

Strategies diverge

SIIF’s 2020 survey showed that Japanese impact investors were much more likely to prioritise healthcare and education, and much less likely to invest in sustainable agriculture than their counterparts globally. Some 70 percent of Japanese institutions invested in education, compared to 41 percent globally, and 65 percent invested in healthcare, compared to 49 percent globally.

These figures reflect how the pioneers of Japanese impact investing have often focused on tackling social problems within Japan. Takatsuka tells PEI that this partly stems from the fact that regional banks, some of which have been early adopters of impact investing, are “facing an emergency situation” linked to the ageing population in their regions. Almost 30 percent of the population is aged 65 or over, per UN figures, making Japan the world’s oldest country by some distance. The demographic challenge is particularly stark in rural areas, where swathes of working age people have long since departed for the cities.

“Wherever we go in Japan, the top social problem is the ageing population and the decreasing population,” says Takatsuka. “Elderly care is a very big issue.” She also lists childcare as an important priority, not least because the provision of quality and affordable childcare will incentivise couples to have more children.

The Hataraku Fund has consequently set its focus on care for both children and the elderly. Its strategy sits neatly with the government’s aim of achieving ‘regional revitalisation’. The Japanese government, along with many municipal and regional administrations, have been deploying social impact bonds as a means to help revitalise regional economies since 2015.

With so much focus on addressing Japan’s social problems, it has been harder for managers to fundraise for vehicles that aim to achieve impact outside of Japan itself. SIIF’s figures show that only 26 percent of Japanese investors backed food security or sustainable agriculture, for instance – far below the global average of 57 percent.

Ultimately, says Takatsuka, asset owners need to be convinced that impact investing fits in with Japan’s efforts to reform its economic model and address the most pressing social and environmental challenges domestically and globally. “We have to incorporate impact somehow into our market decision-making,” she says. “What really should attract institutional investors and private individual investors is not only growth, but also the story behind the growth.”

Measurement vital for industry to reach maturity

Impact investing remains a fairly novel practice in Japan.

Pioneering impact funds need to demonstrate successes to convince hesitant institutional investors of the value of impact investing. To do this, much like elsewhere in the world, Japan needs to solidify metrics for measuring impact. Shinsei Corporate Investment’s Sayaka Takatsuka notes that Japan has often been “absent from the discussion” on global impact frameworks and she warns that there is a lack of personnel with training in impact measurement and management.

But there are some promising signs that the situation is changing. The PRI’s Daniel Wiseman reports that Japan’s Financial Services Agency “is currently working with impact investing industry groups to develop a Japan-specific impact measurement methodology”. He says that this “could help to support greater consistency and clarity”.

Chisa Ogura, managing director at Meros Consulting, agrees that the standardisation of impact measurement is a key priority for the industry. “Once it’s more standardised, my personal feeling is it will become easier for Japanese players to jump into this area, because it becomes easier for them to understand.”