Activist funds ditch Japan, leave governance void

* 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 raising 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.

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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.