After decades of false dawns and dispiriting results, it seems the tide is finally turning for investors in Japan. On 22 February the Nikkei 225 index breached its previous 1989 record high of 38,915, ending the day at over 39,0001; indeed, Japan has been the best-performing major market of 20242.
Critically, though, this strong performance is underpinned by fundamental changes in the way Japanese companies are operating. For Nicholas Weindling and Miyako Urabe, managers of JPMorgan Japanese Investment Trust (JFJ), the biggest single factor in the turnaround has been the ongoing shake-up in corporate governance, which has gathered pace dramatically over the past 18 months or so.
“Japanese corporate governance is undergoing nothing short of a revolution,” says Weindling. “In particular, the Tokyo Stock Exchange (TSE) has been putting a lot more pressure on companies to do something about their low valuations, and that’s sparked some major changes in the last 12 months.”
Corporate actions reflect a change in corporate governance
One spectacular consequence is the pick-up in share buybacks by companies, which have been hitting new highs each year since the pandemic and are now well ahead of pre-Covid levels; that trend has continued into 2024. As Weindling points out, however, the job is by no means done yet: “Still, 50% of Japanese companies have a net cash position3, so there is much further to go.”
Further evidence of the governance overhaul can be seen in the number of companies unwinding their strategic holdings in other businesses over the last 12 months.
This direction of travel is potentially a very big deal, Weindling observes. If all Japanese companies disposed of their strategic shareholdings and used the money to buy back their own shares, the Japanese market’s return on equity would rise from roughly 9% to 12%2.
Japan’s Financial Services Authority (FSA) has recently waded into the melee alongside the TSE and local asset managers, pressurising the companies under its regulation – life insurers in particular – to get on with the job and unwind their shareholdings.
Mergers and acquisitions are also on the rise as confidence gradually rises. “We’re starting to see levels and types of activity we never thought we’d see in our time in this job,” says Weindling. He points to one portfolio stock which was subject to a hostile takeover in 2023, while another was bid for by the Japanese Government Investment Corporation.
Meanwhile, management buyouts hit a record high last year, and have if anything intensified in frequency so far in 2024, with new announcements “almost every week”.
So, there is a great deal to be positive about in regard to share activity and ownership, including other less obvious trends. For example, not only is the TSE keeping up its pressure around governance, but local asset managers are also becoming much more vocal and active as shareholders, Weindling reports.
Moreover, there is also a sea-change in senior management taking place, with the retirement of a tranche of conservative elders and the emergence of a new generation of more proactive, progressive business leaders. “Taken as a whole, it’s a very powerful mix – and it’s really gaining momentum,” he adds.
Reforms lead to new investment opportunities
For the JFJ team, this broad theme of improving governance is an important consideration in addition to the Trust’s high-conviction, quality- and growth-focused portfolio.
One example from last year is Japan’s leading security systems provider, Secom. The company accounts for 50% of the domestic market, and is very stable and highly profitable4; however, it has historically been heavily overcapitalised, with more than 600 billion yen in cash. JFJ took a position in 2023 based on encouraging signs of change.
“Secom has recently started to change its stance, conducting the first buyback for 20 years,” explains Urabe. “It has also recently announced the first price hike in 30 years; given the upward direction of wages in Japan, we want companies with pricing power.”
Other relative newcomers in the portfolio are also there in part because of policy improvements: car manufacturer Suzuki was “historically behind the curve” in regard to shareholder returns, but has been reappraising its capital allocation policy, while chemical business Osaka Soda raised its dividend payout ratio last autumn.
“When you have this combination of strong earnings growth and balance sheets plus the improving governance angle, we believe that’s very powerful,” Urabe explains.
The Trust’s performance is already benefiting from what appears to be a shift in investment style over the past few months – away from the previous two years’ domination of value-focused holdings, and towards growth.
Over the last three months of 2023, the Japanese market (as measured by the Topix index) delivered strong returns of around 3.4%, but JFJ outperformed substantially, gaining more than 8% over the period5.
Weindling returns to the structural shifts occurring in the way companies are run as a core element of recovery, both for the wider market and for the Trust itself. He points to the top contributor to the portfolio in 2023, Shin-Etsu Chemical Co, which had a great year following a shake-up in senior management.
“The company had been very overcapitalised, with more than $1bn in net cash; but very soon after the founder passed away and younger directors took over, we saw a change in dividend and share buyback policy, which was very positive for shares,” he explains. “It’s emblematic of the generational shift we’re seeing.”
As the momentum for change in governance gathers pace, and with sentiment towards companies that can deliver meaningful growth picking up, the outlook seems a rosy one for JFJ. With the Trust being managed locally and supported by a team of over 25 specialist investment professionals in Tokyo, this significant on-the-ground presence provides the essential insight needed to discover new opportunities in an under-researched market.
Find out more about the JPMorgan Japanese Investment Trust (JFJ)
The companies above are shown for illustrative purposes only. Their inclusion should not be interpreted as a recommendation to buy or sell