Japan's hottest-selling mutual funds (MFs) could see a slowdown in their explosive growth due to increased regulatory scrutiny at home and an uncertain outlook for the currency of a nation half a globe away. * Double-decker funds grow to $114 bln after starting in 2009 * Regulatory measures,Brazilian rate cut may slow rapid rise * Japan FSA especially worried about huge inflows into Brazilian real * Japan regulators tighten distribution rules * ASEAN-focused funds getting popular,say fund industry sources These funds,loosely referred to as 'double-decker' funds, bundle high-return assets,such as junk bonds,and high-yielding currencies,mainly the Brazilian real . They have been the rage among Japanese investors in the past two years in an environment of persistently low returns. They have drawn massive inflows and their assets now make up nearly 15 percent of the $840 billion Japanese mutual fund industry,in less than three years. This rush of money,especially into the currency of Brazil,which unexpectedly cut interest rates late last month,has got Japan's Financial Services Agency worried. Double-decker funds invested in the real accounted for 60 percent of the segment's total assets,as exposure to fast-growing Brazil,with an appreciating currency,was a natural choice for Japan's savers. But there are signs a slowdown may be looming. Inflows into the real-linked funds may slow down,said Genzo Kimura,a bond fund manager at STB Asset Management,the fund management arm of Sumitomo Mitsui Trust Holding . Their performance has been hit by falls in the real and the outlook is not necessarily convincing as Brazil may ease further. Japan households,with some $15 trillion in personal assets,have been diversifying their portfolio,seeking higher-yielding instruments with steady monthly dividends as domestic interest rates remain pegged near zero and as Tokyo stocks have struggled. BETS MAGNIFIED Double-decker funds were first launched in 2009 by Japan's top money manager Nomura Asset Management. These funds initially invest in high-yielding assets such as equities,bonds,gold and real estate investment trusts. The income from these are then invested in currencies such as the Brazilian real. Foreign exchange derivatives are used to magnify those bets. The funds enable investors to collect income from the original asset and from currencies,which make it possible for them to receive high monthly dividends. Nomura's funds,which combined U.S. high-yield bonds and currencies such as the real and the Turkish lira ,became instantaneous hits,prompting rival fund managers such as Mitsubishi UFJ Asset Management and UBS Global Asset Management to follow suit. Returns on a few of these funds have been as high as 60 percent over the past year,versus a flat performance for Japan's main stock index over the same period. A total of 415 such funds have been launched in Japan and their assets added up to 8.8 trillion yen ($114 billion) as of end-August,data from Lipper,a unit of Thomson Reuters,showed. That pace may be difficult to sustain. The FSA has expressed concern to asset management companies about Japanese households' large exposure to the real,industry sources said,forcing some asset managers to drop plans to launch new products linked to the Brazilian currency. We are trying to structure funds that are not linked to Brazil because we are worried about the FSA,said a senior executive at a Japanese money manager,who did not want to be identified because of the sensitivity of the matter. The funds are also facing new restrictions on how they are sold to investors. The FSA,the Japan Securities Dealers Association (JSDA) and the Investment Trusts Association are requiring distributors to provide more disclosures when they market double-decker funds and dividend-oriented products. We are doing this as a precautionary measure. There is a potential danger as these products are very sophisticated,said Koichi Hirata,executive director at JSDA. These are the main products in the mutual fund market. So it is very important to make sure that investors understand risks and to remove any misunderstandings,Hirata added. The FSA emphasized it is not planning to impose restrictions on structuring of new products. We don't have any plans to impose restrictions when structuring such a product,said an FSA official. We cannot tell distributors not to sell them because they are sophisticated. We are well aware that such products are drawing huge demand so we are watching these moves with great interest,he said. OPTIONS EYED A slowdown for the segment may have already begun,recent data suggests. Assets of double-decker funds that invest in the Brazilian currency shrank by 3.6 percent to 5.3 trillion yen in August from a record 5.5 trillion yen a month earlier due to the poor performance of high-yield investments after the European debt crisis intensified,Lipper data showed. And this was even before the real's outlook turned uncertain as Brazil cut interest rates by 50 basis points to 12 percent on Aug. 31. The real fell more than 5 percent against the U.S. dollar to a six-month low last week after the rate cut. The performances of the funds have also been a mixed bag. While the Nomura Gold Futures fund returned 50 percent over the past year till end-August,the Deutsche Euro High Yield Bond fund returned just about 5.5 percent over the same period. And the Deutsche fund has lost 14.3 percent over the past three months,Lipper data showed. Some investors have started looking at options to real-linked double-decker funds. Fund managers and distributors are preparing to offer more mutual funds investing in Indonesia,Vietnam and other ASEAN markets,fund industry sources said. Still,some believe that double-decker funds linked to Brazil and other high-yield currencies will find favour with investors. Many of them are still performing well. On top of that, dividends for these funds are still very attractive so investors may be reluctant to sell them now,said Shoko Shinoda,a fund analyst at Lipper. Masaru Hamasaki,senior strategist at Toyota Asset Management,said while Indonesia and other Asian countries may vie with Brazil to be alternatives,Japanese investors would favour the Latin American nation due to its status as a big commodities player and because of its developed debt market. Brazil still offers double-digit interest rates. So I don't think there is an imminent risk of Japanese pulling out altogether from the real,Hamasaki said. ($1 = 77.325 Japanese Yen)
