No investment comes without a level of risk – even cash, particularly with interest rates as low as they are and the potential threat of inflation looming. But when we are dealing with investment markets we’ve often been led to believe that pooled investments with a focussed number of shares present a greater level of risk. In a market like Japan, I couldn’t disagree more.
Japan, as we all know, has been in an unprecedented period of low-to-no growth and equity income has been the sanctuary of many an investor portfolio. Even then good returns come down, largely, to good stock picking.
From a growth perspective, investors in Japan have been disappointed time and time again. However, with corporate fundamentals continuing to change, particularly in relation to their attitude to shareholders (thanks not least to policy shifts), and given the cash surpluses available from years of hoarding, Japanese equities are now offering greater returns to shareholders than both US and European equities. Dividend growth in Japan increased by an impressive 15 per cent last year and the buyback of shares increased dramatically to a new record total.
Performance of fund vs sector & benchmark over 5yrs
Source: FE Analytics
Some might feel that running an equity income investment strategy in Japan is niche enough and to focus on a maximum of 40 stocks within that portfolio is a step too far. Whilst I can’t speak for other investment managers and the markets they might invest in, I have always thought that running a focused, unconstrained strategy in Japan is essential to delivering sustainable returns.
Active investment is crucial in Japan
Whilst there are several excellent companies in Japan, the long-term prospects of many may well be unsustainable. As a result, an investor wanting to access the best equity income opportunities in the country by simply buying a tracker or ETF will be sorely disappointed.
We are happy to invest across market cap spectrum and believe that there are sometimes advantages to investing in smaller companies over and above their larger counterparts. Firstly, with many of the small-cap stocks (as is the case for the stocks in the portfolio) a significant proportion of the shares, sometimes 40 per cent or more, are owned by the management themselves. This is significant because as shareholders, the key decision makers in the company understand the importance of fulfilling investor needs. There is a stark comparison here to most large caps where management tend to own very little or no stock at all so have a very different understanding of shareholder requirements.
Know your company
By keeping a focused approach, only the very best ideas will make it into the portfolio. Whilst the treatment of shareholders has been improving for some time in Japan, it’s still very much at an emerging stage and there are many companies who have yet to appreciate its importance. It would be relatively easy to put together a portfolio of just the highest yielding stocks but we believe it’s far more important, from a sustainability point of view, to understand what is motivating the management to pay dividends and analysing their ability to enhance the returns going forward.
Most companies in Japan make valid claims to be run for their stakeholders but each place different priorities on shareholders, employees, suppliers and customers. Many companies concentrate too heavily on their relationship with their customers and as a result their margins are low and there’s little understanding of the role shareholders play. We focus only on companies that demonstrate the right balance.
Avoid value traps
Taking a short-term view is risky in Japan and while some companies appear to offer good value, the longer-term prospects are inhibited by the well documented challenges facing the Japanese economy. Investors waiting for management change or third party intervention to release the inherent value are more than often disappointed. As a result, we only invest in companies that can demonstrate through favourable attitudes to shareholders the release of their intrinsic value.
The upshot is that maintaining tight focus on a short list of companies, in a market that is really just at the start of rediscovering an appreciation of shareholders, is paramount; indeed, it is a hugely effective way to limit unwanted ‘surprises’ and control risk. Equally, in getting to know management teams well, we are able to build a long-term relationship that sees us as active ‘owners’ not simply passive shareholders.
Richard Aston is portfolio manager of the CC Japan Income & Growth Trust. The views expressed above are his own and should not be taken as investment advice.