01 Jun 2023
For active stock pickers, Japanese equities could offer opportunities that are otherwise potentially hiding in plain sight. As corporate governance continues to evolve in Japan, and the doors open to a more shareholder-friendly environment, culturally aware investors who have earned the right to engage may be able to add value and unlock latent potential in the country’s stock market.
Japan, the 1980s. The country was an economic powerhouse, its stock market was soaring. On 29 December 1989, the Nikkei Index reached an all-time-high of 38,9161. But the 1990s proved a far more challenging period – the economic bubble burst, and stock prices collapsed. Japanese companies, wary of over-leveraged balance sheets, generally sought to accumulate cash instead of vying for shareholder return improvements. The ‘boom years’ were over, what followed was a so-called ‘lost decade’ of economic stagnation with Japanese corporate governance generally lagging global best practices at the time.
“In contrast to the more cyclical inflation in other developed nations, structural inflation has taken hold in Japan. This could provide a fantastic backdrop for corporates to accelerate productivity.”
Much needed reform was in order. Indeed, it took over three decades for the Nikkei index to near those heady heights seen at the end of 1989, when in February 2021 it breached the 30,000 milestone, with strong corporate earnings and GDP data as well as optimism over Covid-19 vaccine development2.
Now, thanks to self-help, Japan could be the best market globally for earnings growth in the decade ahead. Margin growth, capital reduction from higher dividends and buybacks along with accelerated M&A trends may all bode well for shareholder returns.
Since Abenomics emerged a decade ago, the Japanese corporate landscape has undergone significant change. This state-sponsored campaign to improve both corporate governance and capital management was followed by a decade of remarkable self-improvement and there is potentially more to come.
Abe’s reforms not only encouraged an incentive structure for genuine change, but also provided the much needed institutional, administrative, legal and governance apparatus required for successful delivery. Evidence in the past two to three years of significant change is now overwhelming. We believe the stage is set for both meaningful value creation and value release from factors largely controllable by companies themselves.
Japan’s corporate sector continues to undergo a structural shift in mindset that is potentially highly favourable for profits, return on invested capital and owners of equity. The shift started with Abe’s third arrow of reforms ten years ago. The implementation of a stewardship code in 2014 and a corporate governance code in 2015, for example, helped pave the way for Japanese companies to accept corporate governance and become more shareholder-friendly.
Current prime minister, Fumio Kishida, looks to build upon this trend of corporate improvement, placing a vibrant corporate sector at the heart of his policy agenda.
Despite being the world’s third-largest economy3, the Japanese stock market remains largely overlooked by global investors, a dragon hidden in plain sight. Dramatic change in company behaviour combined with a lack of global attention may create a perfect playing ground for stock pickers with a long history in the market.
The significant self-help opportunity in Japan resides in both balance sheets and income statements. Japanese corporate’s balance sheets are loaded with latent value, awash with excess assets. There is also excess real estate, cross shareholdings and inefficient working capital to take into account.
On the income side – despite a decade of double-digit earnings growth – Japanese company’s profit margins are still around half those in the US. The opportunity lies in duplicative cost structures, excessive business-area diversification, inadequate pricing strategies and low levels of digital transformation. The corporate sector in Japan is now addressing these issues with accelerating fervour.
The self-help opportunities exist in a macro environment where we are seeing structural inflation finally taking hold in Japan, in contrast to the more cyclical inflation in other developed nations. This could provide a fantastic backdrop for corporates to accelerate the rate of productivity and increase margins.
In order to add value as shareholders, investors need to have earned their credibility through knowledge and experience. This does not happen overnight, however. Investors need to understand Japan’s cultural and corporate landscape to be able to make the kinds of informed suggestions that may add value to Japanese companies.
“Our voice as shareholders has become more valuable and we work hard to use that voice to help investees, whether it be through strategic reviews or introductions to potential customers or suppliers or R&D collaborators that we might own elsewhere in our portfolio,” explains Carl Vine, co-Head of Asia Pacific Equity Investments at M&G Investments.
“As investors with a long history of investing in and engaging with Japanese companies, our value added shareholdership is being appreciated by company management more and more. We continue to bring our unique perspective, backed by a strong history of stewardship in M&G, to our investee companies with the aim to drive excess returns,” he adds.
For Vine, who has 25 years investment experience in Japan, engagement is a valuable part of his investing ‘toolkit’. From suggestions on business strategy and personnel to dividend policies, he believes actively engaging with management teams is not only the duty of an active manager, but also helpful to unlock a company’s true potential.
1 Nikkei Asia, “Nikkei index hits 30,000 for first time in three decades”, (asia.nikkei.com), 15 February 2021.
2 Nikkei Asia, “Nikkei index hits 30,000 for first time in three decades”, (asia.nikkei.com), 15 February 2021.
3 The World Bank, “GDP (Current US$)”, (data.worldbank.org), as at 21 March 2023.
The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast.