“Sweeping change” in the Japanese stock market means that investors should reassess their negative stance on the unloved asset class and consider the long-term potential now being offered, according to Psigma Investment Management chief investment officer Tom Becket.
The Japanese market has been on a strong run in recent years since the election of Shinzo Abe as prime minister in December 2012, who won over the electorate with pledges of bold reform to revive the country’s flagging economy. Once in office, Abe fired his ‘three arrows’ of monetary policy, fiscal policy and structural reform - which prompted a resurgence in investor interest in Japan.
FE Analytics shows that since Abe assumed his premiership on 26 September 2012 the Topix index has made a 113.72 per cent total return, while the MSCI AC World index is up 56.83 per cent. Both of these performance figures are rebased in local currency.
Performance of indices since Abe took office
Source: FE Analytics
However, many investors remain unconvinced by Japan and are mindful of several ‘false dawns’ that have led to heavy losses in the past. The most recent Bank of America Merrill Lynch Global Fund Manager Survey, for example, found that asset allocators have a 5 per cent net underweight to Japanese equities.
Psigma on the other hand runs a structural overweight to Japan, through two largely off-the-radar funds. Becket says that much of his positivity on the country comes from factors far more long term than the ones usually discussed in Japan outlook, such as short-term economic growth, the direction of the Japanese yen, the strength of corporate profits and the success or failure of Abenomics.
“I can almost certainly add no value to your understanding of these subjects, so will simply state that the economy continues to do OK, the yen is likely to persist with its recent weaker tone, Japanese corporate profits have troughed and will be amongst the strongest in the world next year and Abenomics is having a moderately positive impact on Japan’s economy,” he said.
“Much more important to the eventual success of our clients’ investments in Japan and the chief focus of my interrogation is the mightily impressive change that is taking place in the minds of Japanese managements across this fascinating land.
“Fairly branded ‘uninvestable’ by global investors due to poor corporate governance and the general disregard shown to shareholders by management over the last few decades, Japanese shares can now be considered one of the world’s most attractive investments as a ‘corporate self-help’ theme sweeps the nation.”
Becket argues that the most successful element of the “wide-ranging and often ineffectual” Abenomics programme has been the implementation of a Corporate Governance Code. The code is designed to encourage transparent, fair, timely and decisive decision-making by companies that gives due attention to the interests of shareholders, customers, employees and local communities. 
While intended to address many of the concerns investors have historically held about Japanese companies, there has been some disappointment with the speed at which the code has been adopted by corporates.
However, Becket says this should not put investors off. “My personal view is that their disappointment reflects ignorance as to how Japan actually works,” he said.
“Japanese managements will take a slow and steady approach to this, not wanting to commit to vast change. Creedence Clearwater Revival once sang ‘Big wheels keep on turnin’’; the big wheel of corporate change is moving in Japan and the fact it is moving at all is really something.”
The chief investment officer also points out that Japanese businesses tend to abide by a culture of not bringing shame on themselves. In order to use this to encourage them to sign up to the new code, an index of those with good corporate governance - the JPX-Nikkei 400 – to essentially ‘shame’ those companies that do not qualify for inclusion as they are not deemed shareholder-friendly enough.
This index only includes large-caps but versions covering the mid- and small-cap parts of the markets are being planned. Becket says spotting firms that are set to enter these indices could be a “powerful trade”.
“Short-term ‘macro’ investors and hedge funds, in particular, might not have the patience to see how the developments of the code take effect; a broadening of corporate boards, full disclosure and increased respect for your shareholders are ‘soft’ or ‘intangible’ effects and not immediately powerful drivers of share prices,” he added.
“However, for those wanting hard facts look no further than the boom in mergers and acquisitions, share buybacks, rising dividends and elevated profit pay-out ratios. These are all elements that we believe can really get investors excited about investing in Japan. The simple facts are that Japanese companies are generating healthier levels of return on equity, earning decent rates of profitability and are already sitting on gargantuan cash piles, which they are starting to return to shareholders in one way or another.
“Of course, we have seen the potent effect that this has had upon US share prices, even during a period when there has been a protracted earnings recession in the US market. Much of US companies’ largesse was funded through the issuance of fresh debt, which has meant that US corporate leverage has risen to worrying levels; there are no such concerns in Japan as the cash to give back is already there. Oh and I forgot to mention that Japanese equities are generally trading at an unjustifiable discount to global peers and are by all measures are cheap, in a world where nearly everything else looks expensive.”
All in all, Becket says a recent trip to Japan left he “even more bullish on Japanese equities” than when he left. He argues that there is now good reason to expect the inefficient cash on Japanese balance sheets will soon be heading towards shareholders, which has taken the asset class from being “a pariah a decade ago to a paragon of value now”.
To capitalise on the above trend, Psigma is using two funds to take its Japanese equity exposure. Both are domiciled outside of the UK and are not likely to be well known to most investors.
The core of the wealth manager’s Japanese exposure is taken through GS Japan Equity Portfolio. It has outperformed its average peer in the offshore FO Equity Japan sector over the past five and 10 years, but is behind over one and three years.
“The strategy focuses on allocating capital to where the managers are seeing the best opportunities,” Becket said.
“The team are highly experienced, with a strong track record. They have a local presence on the ground in Tokyo, which we believe gives them a significant advantage for the ‘bottom-up’ stock picking approach they use. This is a balanced proposition and we would not expect it to experience high levels of volatility relative to the Japanese market.”
Performance of fund vs sector and index over 5yrs
Source: FE Analytics
Psigma’s second Japan fund is RWC Nissay Japanese Focus, which is managed by Yasuaki Kinoshita. This fund, which launched in March 2015, was bought with the specific intend of exploiting the greater focus on shareholder returns at many Japanese businesses.
It has made 28.07 per cent since launch, outperforming both its average FO Equity Japan peer and the Topix.
“This new discipline from certain companies should be very rewarding for investors in those companies, as dividend increases, share buybacks and greater efficiency of capital drive returns,” Becket said.
“RWC Nissay Japan Focus is perfectly positioned to exploit this trend of improving corporate governance, the fund’s principal focus, which should allow for a continuation of the outperformance the manager has enjoyed for the last few years. The fund has a fully flexible mandate, with the manager investing in those companies that he sees as offering short term value and long term restructuring potential.”
“We are also encouraged that the fund is highly concentrated, allowing the manager a ‘deep dive’ into each company’s internal dynamics and the identification of specific catalysts to realise a re-rating.”
Both funds are domiciled in Luxembourg. GS Japan Equity Portfolio has an ongoing charges figure of 1.90 per cent while RWC Nissay Japan Focus’ ongoing charges are 1.25 per cent.