Many investors’ preconceptions about the Japanese economy and the country’s equity market are hugely misguided, according to Sarah Whitley.
The manager, who co-runs the Baillie Gifford Japanese fund alongside Matthew Brett and also heads up the Baillie Gifford Japan Trust, says that the actual headwinds and tailwinds in the region are being overlooked in favour of urban myths.
While the region has been popular among investors over recent years due to economic reforms and improved corporate governance, there are still some investors that remain sceptical.
Performance of indices over 3yrs
Source: FE Analytics
One myth that is sparking doubts, she says, is that the economy could hit a downward spiral due to the country’s declining population, which would leave behind a smaller workforce and the need to care for a greater number of elderly citizens.
More than a quarter of Japan’s population is aged 65 or over, and the Japanese Health Ministry expects this to increase to around 38 per cent by 2055.
“I find this obsession with demographics in Japan rather odd. When we invest in Japanese companies and they have businesses around the world. The best manufacturers have most of their businesses around the world and not very much in Japan, but people always obsess about Japanese demographics,” Whitley said.
“Why not German demographics or Russian demographics, for instance? There are a lot of countries that have demographic issues. Japan doesn’t have the demographic issues that a lot of Asia has -there are huge gender skews in some Asian countries for example and that really affects your population.”
While the manager says the population is aged and it is declining, it isn’t drastic. An important point that people forget, she says, is that it’s the Japanese population that isn’t growing and not Japan’s total population. According to Baillie Gifford’s data, there are already 3m people from foreign countries living in Japan and this is expected to increase significantly over the years.
Despite this, there is still a labour shortage in the region at the moment. Whitely says that currently, for every 12 job offers in Japan there are only 10 applicants as the work force continues to contract and the demand for workers increases.
Again though, she warns that the shrinking number of workers isn’t as catastrophic for the economy as many investors may think, partially due to unreliable economic data being supplied by the Japanese government.
“We’ve already had a big shift of women back into the workforce – the participation of women in the Japanese labour force is at a record highs and reaching international norms. This means there isn’t a big pool of unused labour and wages are rising,” she pointed out.
“There also isn’t a big issue with wages in Japan but with the wage data, which is pretty rubbish. People will tell you that wages are not rising but I think they are, and I think they’ll rise further next year. Profits are rising this year, they’re probably going to rise another 7 to 8 per cent the following year.”
The manager says that currently, average wages are derived from total wage bill averages within companies, which does not take into account differences between senior, highly-paid figures and inexperienced, younger employees.
As a result, she believes wage data to be fundamentally flawed and instead relies on meeting as many Japanese companies as possible to gain a better understanding of the country’s economic situation.
One big change in Japan that Whitley believes will remedy this is the introduction of My Number, a social security and tax number system which is set to be implemented next year.
“This will make tracking what is actually happening to individual incomes much easier and it will also probably lead to even more buoyant tax revenues,” the manager said.
While tax revenues have been very strong over the last few years, she says that many people might be unaware of this because it isn’t discussed by Japan’s Ministry of Finance due to their severe austerity plan.
What is common knowledge among investors though is the implementation of Abe’s Abenomics, which is a series of economic policies divided into three ‘arrows’ of fiscal stimulus, quantitative easing and structural reforms.
However, this has come under scrutiny by the financial media, as many investors are concerned that the reforms haven’t been fully implemented yet.
“When people write their articles, ‘has Abenomics failed’ the answer is normally yes, but it’s a complicated question. I think it has given more confidence to people that generally things are going to get better rather than worse,” Whitley argued.
“What it hasn’t done yet is crack the deflationary mind-set. We have had the issue that prices have risen and that incomes haven’t risen yet, but Japan has been enormously helped by the fall in the oil price as it’s the largest national oil importer.”
“Then you have these data quality issues with things like how wages are going up, which don’t help matters. I’ve heard different views from people that should know better, who say some bonuses were cut 2.5 per cent, and apparently the Ministry of Health and Welfare who comes out with this data completely revamped the way that they collected the data without the help of any statisticians and didn’t revise the previous series, so that data is completely meaningless.”
In spite of the myths and the inconsistency of data coming from the region, the manager says that there are still plenty of bottom-up stock-picking opportunities in Japan, and that it is important for fund managers to speak directly to companies and conduct thorough research.
As such she is confident that Baillie Gifford Japan Trust and Baillie Gifford Japanese, which are both in the top quartile over three and five years, will continue to do well.
“I always find this obsession with the Japanese economy a bit odd,” she added. “There are lots of companies that we don’t want to invest in that aren’t growth companies. We invest in attractive growth companies, we’re not investing in the economy per say.”
Performance of trust vs sector and benchmark over tenure
Source: FE Analytics
The Baillie Gifford Japan Trust, which Whitley is the lead manager of, has returned 278.75 per cent over her 24-year tenure. This is 177.23 percentage points more than its peer average in the IT Japan Equities sector and more than 18 times the total return of its TSE TOPIX benchmark.
The trust is trading on a 6.2 per cent premium, is 14 per cent geared and has ongoing charges of 0.89 per cent.
