Investors in Japanese funds have had to put up with many false dawns over the past decades of stagnant economic growth and chronic deflation. But there are strong reasons for believing that the current flurry of positivity around Japan’s macroeconomic outlook is well-founded.
“I don’t think it’s an exaggeration to say that this is the most exciting time in the Japanese market for the past 20 years,” comments Nicholas Weindling, the Tokyo-based portfolio manager (with Miyako Urabe) of JPMorgan Japanese Investment Trust (JFJ).
There are several reasons for believing that this time things will be different; but in his view, by far the most important is the huge increase in momentum underpinning changes in corporate governance.
Improvements in the way companies are run have been on the radar of Japan fund managers since the country introduced its Corporate Governance Code in 2015, and businesses have been gradually upping their game in terms of dividends, share buybacks and appointment of outside directors.
But the past six months have seen a step change in progress. Early this year the Tokyo Stock Exchange asked companies trading at a price less than their book value to draw up plans to show how they intend to improve corporate value.
Weindling reports that this new pressure to take action has had a profound effect - particularly given that many Japanese companies are in this position.
“We were already seeing pressure from disgruntled foreign investors, more disclosure from pension funds, and also more activist investors in Japan, but now we have the bourse itself pushing in the same direction,” he observes.
Moreover, there are some relatively easy fixes available to many companies affected. Many have too much equity, either in shareholdings or in net cash – half of all Japanese companies have a net cash position, a much higher proportion than elsewhere in the world – and they are now taking action to improve their capital allocation.
Japanese companies respond to peer pressure to announce significant dividends and share buy-backs
“We are currently in the Japanese full-year results season, and the strongest trend we’re seeing is announcement after announcement of significant dividends, and also share buybacks Weindling says. “No Japanese business wants to be the one that goes against the grain, so there is real momentum behind this trend.”
He maintains that these “massive improvements across the whole of the market” are the crux of the matter for long-term investors looking five to 10 years ahead. Nonetheless, there are other factors worth bearing in mind. For a start, Japan is behind much of the rest of the world in the economic cycle, and in its recovery from the impact of Covid.
For instance, only in mid-May did the Japanese government stop its daily Covid count, while foreign tourists have only been able to visit freely since last autumn. “We’ve seen a big surge in tourism recently, and that doesn’t yet include Chinese tourists,” Weindling reports.
Indeed, the reopening of China, Japan’s largest trading partner, is also providing a boost for the many Japanese businesses whose earnings have been impacted by Chinese lockdown over the past three years.
JPMorgan Japanese trust has a strong bias to high-quality growth companies of all market caps
Domestically, meanwhile, there are signs of price inflation and wages are starting to rise, which is also likely to help boost economic growth. “We’re not looking at double-digit rises as we are in the UK but this is the first time they have risen in roughly 30 years, so it’s a significant development,” says Weindling.
These factors, taken in conjunction with valuations still at compellingly low levels, make for a powerful investment case, he believes – and evidence of its strength lies in the recent visit to Tokyo of none other than Warren Buffett.
“For Berkshire Hathaway, Japan is now the second biggest area of investment outside the US, and at the AGM Buffett was absolutely clear that they intend to increase their exposure to this region.” Says Weindling.
How does JFJ’s perspective serve it against such a backdrop? The trust takes a high-conviction, bottom-up approach, with a strong bias to high-quality growth companies of all market caps that can compound earnings over the long term. The trust aims to produce capital growth from investment in Japanese companies, and has the ability to use gearing (5% net cash to 20% geared) to increase potential returns to shareholders.
“The kind of stocks that we invest in tend to have very strong balance sheets, and so in regard to capital allocation improvements there is plenty of room for them to do more on that front,” explains Miyako Urabe.
JFJ’s quality growth focus meant it has had a difficult time over the past couple of years, particularly during 2022’s indiscriminate sell-off of growth-oriented businesses. As Weindling notes, its high-conviction, unconstrained nature can mean it is susceptible to short-term volatility.
But quality shines through: the portfolio companies have robust fundamentals, and performance has stabilised in the past few months as inflation and interest rates have shown signs of peaking.
Where are the managers finding their best ideas? Although it’s a ‘go-anywhere’ fund, certain themes have come to the fore within the portfolio.
These include, for example, digital innovation and internet: “Japan trails the US and UK by years in terms of penetration of e-commerce, cashless payments and software services – but we’re all traveling in the same direction, we’re finding a lot of attractive ideas, and we believe the growth runway is significant,” observes Urabe.
World-class consumer brands also account for almost a quarter of the portfolio. These include names like the gaming giant Nintendo, Fast Retailing Co, which owns the fashion brand Uniqlo, and bike gear leaders Shimano.
As new corporate and macroeconomic forces increasingly shape a Japanese market that remains exceptionally cheap, JFJ’s focus on the best forward-facing growth businesses should provide investors with an outstanding opportunity to capitalise on change.