For the last several decades, investors in Japanese equities have faced a variety of challenges, from sluggish economic growth to weak corporate governance standards. However, things may finally be starting to pick up. An improving economic outlook is combining with corporate governance reform and favourable technical factors to create a more positive backdrop for long-term investors. In this environment, our research analysts can pair local intelligence with insights from their global counterparts to find multi-year investment opportunities.
Drivers of Japan’s economic growth
Japan’s economy is finally getting a boost from several improving trends. Having been late to reopen post Covid restrictions, the economy is only now enjoying the rapid growth from normalisation that other countries experienced in 2022. For example, inbound tourism is approaching 2019 levels and is helping drive GDP growth.
The bigger economic story in Japan is the return of inflation, after decades of low inflation or even deflation that depressed growth. Inflation in Japan reached a 40-year high of 4.1% earlier this year and rising prices are now fuelling the fastest pace of wage growth in 30 years, providing a critical boost for economic growth.
Shareholder value boosts investment opportunities in Japan
Against this positive economic backdrop, the corporate governance revolution that started in 2014 is picking up speed with some major developments this year that are good news for equity investors.
The Tokyo Stock Exchange (TSE) has stepped up efforts to improve equity valuations and make Japanese companies more shareholder friendly. This year, the TSE is demanding that companies trading below book value (that is, companies whose stock market value is less than the net value of their assets) come up with a plan to increase their valuations. We have been positively surprised by how many companies want to talk about the changes they are making.
At the same time, share buybacks are also accelerating, helping companies improve their capital efficiency while increasing shareholder value.
These developments are important because Japanese companies have more potential than companies in many other markets to create value simply by optimising their capital allocation and balance sheets. One reason is that more than 50% of Japanese companies have net cash positions (the cash on their balance sheet is greater than their liabilities). Essentially, Japanese companies have the potential to put this cash to better use on behalf of shareholders.
Another opportunity for Japanese companies to improve their capital structures is through unwinding cross-shareholdings – a common, yet complicated feature of many Japanese companies where they own stakes in each other. Cross-shareholdings are problematic for corporate governance as they can prevent proper scrutiny of management on behalf of general shareholders, potentially depressing a company’s return on equity (ROE) – how effective it is at turning shareholder equity into profits. Unwinding cross-shareholdings could therefore help to boost Japan’s corporate profitability and unlock further shareholder value.
Impact of corporate governance reform
The corporate governance changes are also shaking up Japan’s notoriously conservative and insular corporate culture. Japanese asset managers must disclose how they vote at annual general meetings and we’re starting to see large votes against senior management at some major blue chip companies – a previously rare occurrence – to promote issues such as board diversity. In a further challenge to the conservative corporate norms, domestic pressure is also leading to generational change in corporate leadership.
The positive momentum in the economy and corporate governance is leading to a virtuous cycle where investors are now coming back to Japan, which is improving the technical backdrop. After years of being underweight Japanese equities, more investors may begin to move back toward at least a neutral position and some may go further: Warren Buffett’s biggest allocation outside of the US in now to Japan.
Leveraging Japanese equities
J.P. Morgan Asset Management’s long experience in Japanese equities underpins our high level of conviction in the current opportunity. We have been investing in Japan since 1969 and our Tokyo-based Japanese equity team of over 20 people has been working together for more than 13 years. This experience with Japan’s economy, corporate culture and equity market allows us to appreciate the significance of the changes occurring now.
Our long-term, local perspective is also enhanced by insights from our global research team. While many asset managers are not based in Japan, our local team speaks Japanese and has developed a deep knowledge of the local equity market.
However, some sectors that are important to Japan’s economy and include major companies, such as autos and chemicals, are quite global in nature. In these sectors our collaborative research process can yield real advantages. For instance, Japanese companies tend to be more guarded when communicating with audiences that do not speak Japanese. Our local analysts conduct meetings with these management teams in person and in Japanese, enabling them to pick up on subtilties and nuances that they can then share with the relevant sector analysts across our global teams.
Global collaboration in action
The JPMorgan Japanese Investment Trust (JFJ) benefits fully from the local expertise and experience of J.P. Morgan Asset Management’s Japan equities team. The investment in Nippon Sanso, a global industrial gas company, is a good example of the team’s approach in action. The industrial gas market is dominated by several major global players. Our analysts like the business because it has high barriers to entry that help produce strong cash flows.
Compared to its top global competitors, Nippon Sanso has high exposure to the Japanese market, leading to lower growth and margins. Recently, the company acquired assets in the US and Europe. Despite official corporate projections of value creation, Japanese companies have been known to overpay in mergers and acquisitions, which can decrease shareholder value. In this case, we were able to gain confidence in the deals because our chemicals analysts in the US and Europe were familiar with the quality of the assets and shared their proprietary assessments with our Japanese chemicals analyst.
We’re now starting to see concrete signs of improving pricing and cost control in the company’s Japanese business. While Japan is still the lowest-margin region, we see scope for improvement in the medium to long term as the company closes the margin gap with the top three global competitors.
Accessing the current investment opportunity in Japan
For investors, one of the many benefits of experience is perspective. At J.P. Morgan Asset Management, our decades of experience in the Japanese equity market provide a long-term local and global perspective. From this viewpoint, we believe we could potentially be looking at one of the best opportunities for investing in Japanese equities that we have ever seen.
The companies/securities above are shown for illustrative purposes only. Their inclusion should not be interpreted as a recommendation to buy or sell