By Sean Thompson, Managing Director CAMRADATA.
When it comes to investment in Asia, China often takes the lion’s share of the press interest. China’s growth outlook, opportunities for foreign investors, concerns on indebtedness, US/ China trade wars and, lately, coronavirus has provided no shortage of eye-catching headlines.
It is easy to forget Japan remains the third largest global economy and stock market. Investment Association (IA) statistics highlighted that UK investors deployed £24.5bn in Japanese all-cap and small cap equities (end 30 Nov 19).
But while the Japanese economy and stock market attract investor attention, there is often a degree of cynicism, with waves of enthusiasm frequently being dashed by disappointing returns. There are many common beliefs and, perhaps, misconceptions that have deterred investors.
These include the fact Japan is an ageing economy in secular decline, Japanese companies are known for their inefficiencies, they lag their global peers in terms of governance, and they are not run in the interests of minority investors. Also, Japan is seen as a ‘value’ market and with China as the dominant force in Asia, Japan is seen to have had its turn.
While some of these may still be true to a degree, there are signs things are changing. The Japanese market is evolving and becoming more attractive to investors. Monetary stimulus, fiscal expansion and structural reforms are all helping to bring this change, which could be exceptionally positive for future investors.
Barriers to change
There are challenges however, both in terms of cultural differences and how companies operate, which can mean change is slow.
One area is the hierarchical nature in corporate Japan, with progression coming from time served by employees rather than achievements delivered. In poorly performing businesses if the workforce is large, but doesn’t want to retire, it can be difficult for management to change this.
Japan has started to address such issues with structural reforms, including several labour reform bills implemented to help raise workforce productivity, which remains at the bottom of OECD nations.
But whilst improvements are being made, there remains a culture of boardroom seats being passed around in many companies, with the same people moving from the boardroom, to CEO, to chairman and then lifetime advisor. This is can limit fresh ideas and impetus. Diversity also remains an issue in Japan. Whilst there has been an uptick in immigration, and women are being encouraged back to work, Japan lags its global peers in terms of embracing diversity.
Seeking growth in an ageing economy
For Equity managers seeking growth, they could consider two approaches. One option is to look for Japanese global leaders in large cap multi-national companies and the other is to search domestically for under covered smaller and mid-sized companies with a clear runway of growth.
Taking the first approach, Japan has global leaders in precision manufacturing and robotics on the industrial side and some consumer brands including cosmetics and baby product brands that appeal strongly to rising middle classes in emerging economies including China, India and Indonesia.
Examples of Japan’s global successes include Pigeon, a Japanese baby products company which has seen explosive sales growth from expanding into China and Toyota, the poster child for manufacturing excellence which is top of global car manufacturers in terms of sales volume.
For a global investor, investing in a Japanese equity portfolio of global businesses on an unhedged basis delivers a natural hedge thereby calming currency volatility. Though it has not always been the case, leaving a Japanese equity portfolio unhedged often makes sense in the portfolio context.
The second approach means fishing in different pools for growth and scouring the market for growth in mid/small caps. This is where a thorough understanding of Japanese culture and language can be hugely beneficial in order to analyse the culture of smaller companies.
The Japanese equity market has unique characteristics for potential alpha generation, the tech-savvy children of Millennials, and there is enormous dynamism in start-ups with differentiated business models. The depth of Japanese small and mid-cap stocks to choose from is substantial too.
A lack of M&A activity, historic listing of subsidiaries and companies listing considerably earlier than their global peers has resulted in a huge range of companies to choose from. The rise of the internet has levelled the playing field on informational access, but some equity managers continue to see great value in visiting company headquarters and manufacturing sites and interviewing members of the supply chain and customers in Japan and abroad.
Travelling beyond the financial bubble of Tokyo to the regions can deliver less commonly examined opportunities and intelligence on production capabilities, and company culture too. Often these earlier stage companies have dynamism and higher quality management coming from top tier Japanese universities with a more entrepreneurial mindset. These companies can offer investors great opportunities.
There is a new dawn for investors in Japan, but this comes with a note of caution for investors who will need patience to understand this will take time. While analytical scepticism remains essential, the green shoots of change make the Japanese market well worth monitoring for opportunities and return in a balanced portfolio.