“Undervalued world class businesses”
In February the Nikkei 225 index reached its highest point in 30 years, buoyed by vaccine optimism and strong corporate earnings. On the eve of the Tokyo Olympics the Association of Investment Companies (AIC) has spoken to managers from the Japan and Japanese Smaller Companies sectors about the impact of the Games, Japan’s changing corporate culture and where to find the best opportunities.
Impact of COVID on Japan: globalisation being questioned
Taeko Setaishi, Investment Adviser to the Atlantis Japan Growth Fund, said: “I believe that the impact of COVID-19 will prompt significant social and economic structural changes in Japan, creating numerous new investment opportunities. The benefits of supply-chain globalisation are being questioned. The lessons that Japanese management teams have learned from the global scramble for low tech medical supplies like PPE include the need to shorten distances within supply chains and to reduce dependence on hostile suppliers.
“The current shortage of semiconductors has reemphasised this issue, with automobile and other equipment assemblers scrambling to secure supplies of scarce semiconductors in order to avoid plant shutdowns. Japanese manufacturers have responded to the problems by reshoring production. Rather than producing in low-cost locations and selling globally, companies such as Canon, Casio and Honda are shifting to a ‘local production for local consumption’ model. These redesigned production and supply chains, with production partially returned to Japan, will require AI-based logistics systems and equipment investment.”
Thomas Patchett, Investment Specialist for Japanese Equities, Baillie Gifford Shin Nippon, said: “COVID has arguably helped to accelerate several trends that were already underway, including that of wider digital adoption. Lockdowns and social distancing caused even the most conservative businesses to capitulate to efficient online alternatives. This has opened up a plethora of possibilities, beyond the obvious areas of e-commerce and online payments. WealthNavi and Lifenet, for example, are democratizing access to wealth management and insurance by offering simple online solutions in industries otherwise dominated by people-heavy distribution channels.
“GA Technology is addressing the antiquated nature of Japan’s highly fragmented ¥40 trillion real estate market, by providing a one stop digital service for renting, buying and selling properties. Opportunities are even emerging for end-of-life service providers; Kamakura Shinsho brings transparency and simplicity to what is an otherwise extremely opaque, old-fashioned and notoriously expensive affair, by aggregating information online.”
Olympics offer few opportunities
Richard Aston, Fund Manager of CC Japan Income & Growth Trust, said: “From a stock market perspective, I doubt there is any meaningful impact either way. The investment for the facilities was, on the whole, completed well in advance of the original opening date in July 2020. However it is a missed opportunity for Japan to showcase its leading technologies and its attraction as a tourist destination. We hope that the World Expo in Osaka in 2025 will go ahead as planned.”
Taeko Setaishi, Investment Adviser to the Atlantis Japan Growth Fund, said: “When Japan was selected to host the 2020 Olympics the popular expectation was for the event to be a sporting festival that showed the world that Japan had recovered from the devastating 2011 earthquake. The initial Olympics-related business opportunities were in the construction and infrastructure sectors. However, profits from those projects have long since been booked, and in fact were lower than usual owing to soaring demand for materials and labour.
“Meanwhile, the pandemic has trashed previous expectations. Lockdowns, quarantines, restrictions on the sale of alcohol in restaurants and bars have not made Tokyo a fun place to visit. The Olympic Committee has limited viewing attendance to a maximum of 10,000 people per event, thus significantly reducing ticket sale revenues that were meant to defray costs. To make matters worse, the Olympics are deeply unpopular with the general population (an 80% disapproval rating), making it difficult for a company associated with the event to ‘cash in’. The most profitable remaining revenue opportunity is probably for TV broadcasters.”
Eiji Saito, Portfolio Manager of JPMorgan Japan Small Cap Growth & Income, said: “We expect little long-term direct impact from the Olympics, and have not changed our portfolio in response to the event. We look for companies with strong balance sheets and good duration, not those trying to play one-off events. Due to the pandemic, overseas visitors are not able to visit Japan so far this year, but in the longer term, we believe Japanese tourism has a large growth potential, which may provide a source of investment opportunities in future.”
Corporate governance reform is biggest cause for optimism
Eiji Saito, Portfolio Manager of JPMorgan Japan Small Cap Growth & Income, said: “We have seen improvements in corporate governance, and it increasingly looks structural in nature. We expect the Japanese equity market is likely to be supported by the combination of positive factors such as management’s increasing attention to shareholders’ returns, newly emerging innovative businesses led by younger generations and strong growth in neighbouring Asian countries.”
Paul ffolkes Davis, Chairman of Rising Sun Management, the investment adviser to Nippon Active Value Fund, said: “The recent run in the Nikkei, and Japanese securities generally, is welcome and is coming off a low base of underperformance for 30 years. An increasing recognition that, by international standards, the Japanese market is cheap, will not detract from its attraction in the short term. We have a long way to go before any aspect of the Japanese market is fully valued. Apart from the positive fundamentals of many undervalued world class businesses, the Japanese government's own large positions in the domestic stock market and its relentless focus on corporate governance reform (a continuing drive since 2014) mean that the excitement about potential investment returns is only just beginning.”
Richard Aston, Fund Manager of CC Japan Income & Growth Trust, said: “Dividends distributed by companies in Japan have demonstrated a greater resilience during the pandemic disruptions than many of their international peers. These trends are a consequence of the initiatives promoted in the Stewardship Code and Corporate Governance Code which were first introduced in 2014 and 2015 respectively and continue to influence management behaviour in a favourable manner.”
Taeko Setaishi, Investment Adviser to the Atlantis Japan Growth Fund, said: “International and domestic institutional investors alike are expected to respond positively to Japan’s continuing corporate governance reforms. New measures under active consideration include the mandatory appointment of external, independent directors on the boards of Japanese companies.”
Monetary policy and new infection waves present biggest risks
Richard Aston, Fund Manager of CC Japan Income & Growth Trust, said: “The Bank of Japan ETF buying programme has provided support to the market and resulted in a significant exposure to the market. Cautious management of this position will be necessary to prevent market disruption.”
Taeko Setaishi, Investment Adviser to the Atlantis Japan Growth Fund, said: “Setting north-east Asian geopolitics to one side, the major potential risk for Japan over the medium term would be for the country to be swept up in another wave of the COVID-19 pandemic or a more serious variant. This would send the country back into quarantines and lockdowns and delay the recovery in economic and corporate-profit growth. A second, realistic risk for Japan is a fall off a fiscal cliff later this year in response to overly aggressive fiscal and monetary stimulus. This would bring the economic recovery to a halt.”
Eiji Saito, Portfolio Manager of JPMorgan Japan Small Cap Growth & Income, said: “We will continue to treasure hunt for future growth stocks: we have been actively conducting research on companies which have potential to achieve multiple years of growth in sectors such as IT, chemicals, materials and construction. These are likely to benefit from long-term structural trends such as digitalisation and decarbonisation.”
Nicholas Price, Portfolio Manager of Fidelity Japan Trust, said: “Globally, the uncertainty wrought by COVID-19 has shone a light on sustainability – and Japan is no exception. Although Japanese companies generally have lower sustainability scores than their European counterparts, we believe this is not due to any fundamental differences in strategy, but more to do with cultural reasons around disclosure practices and language. By working closely with our sustainable investing team on the ground in Japan, we are able to identify laggard companies that are implementing real change and moving up the governance scale. As these companies improve disclosure, ESG ratings should catch up and the market should adjust valuations accordingly. For investors, this creates an opportunity to benefit from the correction.
“A number of themes present themselves. Certainly, clean energy and environmental efficiency are areas where Japan has some very competitive companies that can supply solutions to meet the regulatory and productivity needs of customers globally. COVID-19 has also accelerated trends in e-commerce and digitalisation. As profits recover, companies will prioritise those areas.”
Why it pays to be active in Japan
Eiji Saito, Portfolio Manager of JPMorgan Japan Small Cap Growth & Income, said: “We are optimistic about the Japanese equity market because the case for active investment in Japan is compelling. Japan is a significantly under-researched market: of over 2,000 companies in the TOPIX, well over 50% are covered by no more than one sell-side analyst. The equivalent number for the US and Europe is around 5%. This leads to pricing inefficiencies which can be discovered by well-resourced and experienced investment teams based on the ground in Japan.”
Thomas Patchett, Investment Specialist for Japanese Equities, Baillie Gifford Shin Nippon, said: “Although Japanese equity markets have only just reached levels last seen 30 years ago, US equities have increased several-fold over the same period. This is despite the fact that Japanese companies have undergone significant improvements and the opportunity set has clearly improved. Furthermore, of almost four thousand stocks listed in Japan, we invest in less than 80. Our portfolio is a high-conviction collection of companies that offer the most exciting growth potential over the long term, and is not a reflection of the Japanese market, or the indices used to assess it.”
Nicholas Price, Portfolio Manager of Fidelity Japan Trust, said: “Japan continues to offer a wealth of under-researched mid to small cap growth companies, where we typically find better business models and returns on equity, and management is more incentivised in terms of shareholder returns. Active managers such as myself, based here in Japan, have the opportunity not only to invest in established global leaders, but also to unearth less well-known companies (including pre-IPO), where lower levels of analyst coverage can often create some great mispriced opportunities.”
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Notes to editors
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