REFILE-Activist funds ditch Japan, leave governance void

(Fixes grammar in first paragraph)

* The Childen's Investment Fund, Steel Partners retreat

* Payouts hurt by global financial crisis

* Smaller investors may become more critical

By Junko Fujita

TOKYO, June 24 (Reuters) - The retreat of two high-profile activist funds from Japan underscores the difficulties such funds face in squeezing value from their investments and raises worries about lax corporate governance in the world's second-biggest economy.

The Children's Investment Fund (TCI) and Steel Partners have been scaling back since last year, joining a growing pool of foreign funds reducing exposure to Japan.

The departure also points to rising frustration among foreign funds that managers are not interested in maximising value, while domestic shareholders, often through complex cross-holdings, want to maintain the status quo.

"Most foreign activist funds have already departed Japan. Only the hard core longer-term investors who must maintain allocations to Japan are left," said Christopher Wells, a partner at law firm White & Case.

"Foreign activists seem to have lost confidence in their ability to reinvigorate Japanese industry."

As Japan's annual season for shareholder meetings peaks this week, only one major overseas fund has put forward a proposal -- a sharp reversal from recent years when a handful waged often high-profile campaigns for fatter payouts.

To be sure, the global credit crisis has dented the activist's case.

NO MORE FAT PAYOUTS

Typically activist funds had been pushing companies to return excess cash to shareholders through share buybacks or higher dividends. These days, that extra cash can mean the difference between survival or bankruptcy as revenues plunge.

But even those that question their tactics believe activists play an important role in keeping pressure on management, and warn their exit could leave a dangerous void.

That's because in Japan big institutional funds tend not to challenge management as they do in the West. Management can also count on banks -- which hold massive amounts of shares to cement ties with their clients -- not to rock the boat.

The lack of independent directors is another issue pushing Japan to the bottom of governance polls, critics say. Japan ranked 35th among 39 nations in the latest report by research firm GovernanceMetrics International.

"Until foreign activist funds made radical proposals, Japanese management was too peaceful," said Katsuhiko Mori, a fund manager at Daiwa SB Investments.

"I don't think those types of proposals are always necessary but we need a certain level of stimulus to boost the level of Japan's corporate governance."

London-based TCI last year sold its 10 percent stake in electricity wholesaler J-Power (9513.T) back to the company after it was defeated in a proxy battle aimed at a higher dividend and at putting a limit on cross-shareholdings with banks.

U.S. hedge fund Steel Partners, which last month toppled the board of loss-making wigmaker Aderans Holdings (8170.T) with the help of shareholders, has been selling down its holdings after struggling to win concessions from management. It invested in more than two dozen Japanese companies in recent years.

Foreign investors sold 3.7 trillion yen ($39 billion) worth of Japanese stocks last year, becoming net sellers for the first time since 2003 and helping drive the benchmark Nikkei average .N225 down more than 40 percent.

At this year's annual shareholders' meetings the only foreign investor group that has submitted a proposal is Brandes Investment Partners, which asked specialty chip maker Rohm Co (6963.OS) to buy back its own shares.

The number of shareholder proposals overall more than halved from 27 last year.

Southeastern Asset Management has not made a proposal, but has said it would vote against the re-election of Nipponkoa Insurance 8754.T President Makoto Hyodo to the board. The U.S. fund was defeated in a similar battle last year.

And while funds may be reducing their exposure to Japan there are signs retail investors may pick up some of the slack and at the same time become more critical due to a broad downswing in earnings that has pushed even corporate bellwethers like top automaker Toyota Motor Corp (7203.T) deep into the red.

A survey by Nomura Securities shows that 78 percent of individual investors will vote against at least one proposal at this year's meetings, up from 68 and 48 percent in 2008 and 2007.

Governance may also soon get a lift from a rule change.

A panel chaired by Japan's trade ministry is pushing for the Tokyo Stock Exchange to amend its listing rules so that all companies will have either an independent director or auditor on the board.

"This year investors are going back to basics. They want to know how companies are going to turn their businesses around," said Kengo Nishiyama, senior strategist at Nomura.

"That means paying more attention in voting for or against board members." (Editing by Saeed Azhar)