Feature | Japan
Show jumper Hiroshi Hoketsu is hoping to break new ground next year. If he is cho- sen to compete at the Olympics in Tokyo, he will be the games’ oldest ever competi- tor at 79 years old. Unsurprisingly, this would not be his first appearance at the world’s largest sporting event. That came in 1964 when the games were last held in his native Japan. But it will be a very different Japan in 2020 to the one where he first climbed onto a horse set off in search of Olympic glory 56 years ago. Back then the economy grew by 11.2% while inflation averaged 3.8%. It is a different story today.
The economy is still struggling to recover from 1992’s asset value col- lapse and the 10 years of stag- nation that followed. In 2018, GDP expanded by 0.8% while inflation also failed to reach 1%. Government debt was more than 200% greater than GDP, a result of almost 30 years of failing to boost the economy. Yet Japan is the world’s third largest econ- omy and home to some of the world’s most visible brands. Shares in Hitachi, Mitsubi- shi, Sony, Panasonic, Nissan, Toyota, Honda and Olympus can be traded on the Tokyo Stock Exchange. And for long-term investors looking to gain exposure to stocks in the land of the rising sun, there could be a few bargains to be found. “What we like about Japan are the valua- tions. They are the cheapest among devel- oped markets equities,” says Lars Kreckel, global equity strategist, asset allocation, at Legal & General Investment Management (LGIM). He adds that more than half of Japanese companies’ trade below book value and the majority are net cash. “This is not some- thing that you see in other countries.” The Japanese equity market has de-rated significantly since the valuation highs of the late 1980s and currently trades at a dis- count to the MSCI World index. But this is not the only reason why valuations are considered attractive compared to their developed world peers.
Investors may be concerned that in Japan those over 65 years of age make up a quar- ter of its citizens. Tight corporate profit margins and the country being usurped as the second biggest economy in the world by China also do not help inspire confi- dence. “All of those things together have led Japan to be a structurally under-owned market, but a market that tends to get bid up aggressively on a cyclical basis,” says Paul Markham, a global equities manager at Newton Investment Management. Kreckel likes Japanese equities from a medium-term perspective believing that they have a lot of potential. “The issue is a lack of catalysts,” he adds. “I struggle to
the heart of its corporate dynamic,” Markham says. “There is too much cohe- sion and not enough desire to disrupt. For equity investors that is a negative.”
REFORM, REFORM, REFORM However, there is one area that should grab the attention of long-term investors. Part of the economic recovery plan that Prime Minister Shinzō Abe is following is corporate governance reform. This includes making companies more share- holder friendly in a bid to attract more international investment.
“There is a positive corporate governance story in Japan,” Kreckel says, but it may
There is no getting around that if you are long on Japanese equities they are sensitive to China-US trade war news-flow. Lars Kreckel, Legal & General Investment Management
paint a particularly bullish picture in the very short term.”
The asset manager is monitoring Japan’s equity market closely. “We need a catalyst and we do not have a high conviction that we are heading for one,” Kreckel says. “We are looking for the right moment to add to positions.” Arthur Kwong, BNP Paribas Asset Man- agement’s head of APAC equities, agrees that there is “no obvious catalyst” to buy listed Japanese companies. Kwong adds that Japanese equities have been on an upward trend since 2012. The problem is that earnings consensus appears to be a little too bullish with almost 60% of companies reporting growth forecasts that are below consensus. “The overall picture of guidance is disap- pointing, but that could leave room for a positive surprise,” he adds. Next year’s Olympics in Tokyo might pro- vide the lift that some sectors need, such as higher demand for hotels and retail, but it appears that any buy signal is likely to be economic. “Social harmony in Japan is at
40 | portfolio institutional | May–June 2019 | issue 84
have gone largely un-noticed by investors. Indeed, Markham adds that the “bits that the market is ignoring the most” are the improvements in corporate governance. “Historically, you could say with some jus- tification that a lot of Japanese companies should not have been listed,” he says, explaining that many preferred to operate like private companies and found share- holders an irritation.
This means that dividends and the num- ber of non-executive directors were low rel- ative to other developed markets. Yet in the past few years the government, the Bank of Japan and the regulator have been encour- aging companies to become more share- holder friendly by raising their governance standards. “What we have seen is compa- nies gradually starting to be more trans- parent around profit forecasts, return on equity targets, higher payout ratios, and so on,” Markham says. Indeed, Japan’s state employee pension fund has been encouraged to take large stakes in the equity markets in recent years on the understanding that companies
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