Negative real interest rates and record low bond yields has resulted in a surge of popularity in equity income, which has inevitably led to extended valuations in traditional markets. A number of experts point to cheap valuations and improving economics as reasons to be optimistic about Japan, but McGlashan (pictured) says there are more subtle changes going on which should see interest from equity income investors.
“Our [JOHCM] Japan fund is now soft-closed but we’re not launching this just because our other product isn’t available,” McGlashan explained. “We want to launch something that is a bit different.”
“Things are changing in Japan – the attitudes to dividends are completely different and we want to benefit from that.”
McGlashan explains the biggest problem with Japan from an income perspective has been companies’ obsession with having high levels of cash on the balance sheet. The manager says this is set to change, however.
“Half of all companies in Japan are cash rich, which depresses their return on equity by a large degree,” he said. “Historically they’ve been indifferent to this, but the recent introduction of a new benchmark – the Topix 400 – rates return on equity as a key measure for inclusion.”
“The Japanese government pension fund, which is the largest pension fund in the world, will soon start using the Topix 400 as its benchmark, and other pensions will undoubtedly follow suit.”
“This gives companies a real incentive to pay dividends. It’s a status thing more than anything else. They’re not going to pay out all of the cash, but I think there will be a lot than there has been.”
McGlashan adds that companies that aren’t part of the index wouldn’t be bought by trackers, giving them another incentive to change their ways.
Panasonic – one of the biggest companies in Japan – will not be included in the new benchmark because its return on equity is so low, McGlashan explains. He says he wouldn’t be surprised if management decides to change its dividend policy because of this.
McGlashan says the government’s plan to encourage domestic investors to invest in the equity market will boost the dividend culture in Japan even further, and the stock market in general.
“One of the policies in Abenomics is that the Japanese government pension fund will have to increase its exposure to equities and other non-bond assets, in another attempt to inflate the economy,” he said.
Domestic bonds account for around 55 per cent of the government’s pension fund, compared to just 18 per cent for Japanese equities.
McGlashan continued: “In January this year the Japanese version of the ISA was launched, which allows investors to invest $10,000 tax free every year. This is a massive development, and a big plus for the market. The question is, where will they invest?”
“Traditional Japanese investors have been very income focused, but they’re not getting anything in terms of yield from cash and bonds. Japanese government bonds are yielding 0.6 per cent while the yield even now from the equity market is 2 per cent. This could further encourage companies [to increase their dividend payouts].”
McGlashan is very positive in his outlook for equity markets, believing a rise of 40 per cent is a real possibility over a 12 month period.
The Nikkei 225 has had a difficult period since last summer, but has held on to much of the gains it made in late 2012 and early 2013. It has performed even better in yen terms over the period, but McGlashan says it remains at an attractive entry point.
“The market is still very cheap when looking at the CAPE [cyclically adjusted real price-to-earnings] ratio. It’s as cheap now as ay any time since 1980,” he said.
Performance of indices since Nov 2012
Source: FE Analytics
“Compare this to other markets, and it’s even cheaper. The UK is as expensive now as it has been since 1999.”
“There will be an announcement of Japanese corporate earnings in May, and I think that analysts have been very conservative in their estimates. Analysts are traditionally very cautious and don’t like to go against the crowd,” he added.
JOHCM Japan Dividend Growth will screen the top 200 stocks by market capitalisation, with at least half in the Topix 100 at any given time. The fund will not have an explicit yield target, as McGlashan and Nash will have a significant emphasis on dividend growth.
[There will be times when] the fund actually yields less than the market, while, at other times, it may have a higher than average yield,” the group said.
Jupiter Japan Income and CF Morant Wright Nippon Yield are among the very few income-focused funds in IMA Japan.
McGlashan, who previously ran funds at Invesco Perpetual for more than a decade, has run the £612m JOHCM Japan fund since its launch in May 2004. It is a top quartile performer in its sector over the period with returns of 62.5 per cent, and has also outperformed over a one and three year period.
Performance of fund, sector and benchmark since inception
Source: FE Analytics
JOHCM Japan is ahead of its Topix benchmark over all of the time periods in question. The fund soft-closed at the beginning of last year, following strong inflows from investors.
The government of Japan’s attempts to reflate the economy is highlighted as the principle reason to be optimistic by bulls – including McGlashan.