Low dividend concentration, a low starting payout ratio and fundamental changes affecting the corporate environment make Japan one of the best areas for income investors, according to Baillie Gifford’s Karen See.
See, who co-manages the Baillie Gifford Japanese Income Growth fund, said several changes to the Japanese corporate environment had occurred since prime minister Shinzo Abe introduced the Companies Act in 2015.
According to See, one of the reasons Japanese companies haven’t historically been able to pay much dividend was the companies’ focus on stakeholders – such as employees, trade partners and banks- over shareholders.
But the new requirement for businesses to have at least two independent directors has made companies more transparent and responsive to shareholders.
“What we have seen since then is a fundamental change the way companies engage,” she explained. “The code has stablished a framework in place in terms of how companies think of setting dividends.
“The money coming back to shareholders in form of dividends has increased nicely, especially after 2015, when the corporate governance code was introduced,” she explained.
The Baillie Gifford manager said: “In Japan they don’t really understand why, if you have an excellent year, you need to reward the shareholders, as they didn’t contribute anything tangible to the company from their perspective. So, dividend is a token of maturity for companies.”
Indeed, the impact of the Companies Act has seen a significant jump in the number of companies with independent directors.
Ratio of companies with outside directors
Source: jpx.co.jp
With at least 90 per cent of the companies that voluntarily have at least two independent directors - compared with a 50 per cent in 2010- the manager noted the picture is completely different today.
“Back in 2010 half of the listed companies didn’t have independent directors on board, which means a lot of the companies were able to run the business without any external challenge,” she said.
She added: “Some companies can decide not to have independent directors but then if they don’t comply they’ll be named by the regulators.
“Although it must be noted that these are no ‘magic workers’, what this change means is that now at least people can start asking different questions like: ‘why is payout ratio so low if the company is making so much profit?’”
The fundamental change in the way Japanese corporates think about shareholder returns, coupled with large amounts of cash on balance sheets also makes the country attractive for income investors, the manager noted.
“We think he amount of cash in Japanese companies’ balance sheets- currently over ¥250trn – is really exciting,” said See. “All this ammunition in the form of cash can just be deployed and returned to shareholders.”
The low dividend concentration in Japanese companies is another reason the Baillie Gifford manager believes Japan is a good place for investors seeking income.
The manager highlighted the situation in the UK, where the top ten dividend payers contribute more than half of the dividend yield of the FTSE All Share.
Dividend concentration in the UK
Source: Link Asset Services
“In the UK, if you want to generate income and for whatever reason you do not like the big banks or the oil industry, your hands are tied as portfolio managers,” said See.
“The top ten dividend payers contribute half of the dividend world, so if you start excluding some of these names your portfolio yield will be penalised and it is very hard for you to make up the loss with other stocks.”
She added: “In Japan, however, the concentration of dividend yield is much lower. The top ten companies only pay a quarter, which is very important as a portfolio manager.
“When I think about which stocks to include, I don’t have to ask: ‘Is it in the top ten?’ We can therefore pick the stocks we like and can still very comfortably yield above the market.”
In comparison with the FTSE All Share, the top 10 largest companies in the main TOPIX index represent just 21.2 per cent of total dividend payers.
The biggest dividend payers from the index include Toyota with a yield of 5.5 per cent, NTT DOCOMO (3.2 per cent), Nippon Telegraph & Telephone (2.5 per cent) and Japan Tobacco (2.3 per cent).
The country’s low payout ratio – the amount of dividends paid to shareholders relative to the total net income of a company – is another reason the manager said Japan offers a good opportunity for income as it has a lower base to increase from.
See said: “Japan has a lower payout ratio than any of the developed markets: 30 per cent compared to about a 60 per cent in the developed markets.
“If Japan was to increase its payout ratio to the level of the US, there will be a 50 per cent of income coming through earnings,
“So, they have a very low starting payout ratio and many of the Japanese companies’ earnings have been really good in the last years.”
The £424.7m Baillie Gifford Japanese Income Growth was launched in July 2016 and is co-managed by See and Matthew Brett. With the aim of producing long-term income and capital growth with a focus on growing dividends.
The fund’s largest holdings are financial services group SBI Holdings, oil company INPEX, GMO Internet, automation specialist FANUC and auto firm Toyota.
Performance of fund vs sector & benchmark since launch
Source: FE Analytics
Since launch the fund has delivered a total return of 39.77 per cent compared with a gain of 34.66 per cent for the average fund in the IA Japan sector and 33.21 per cent gain for the TSE TOPIX benchmark.
Baillie Gifford Japanese Income Growth has an ongoing charges figure (OCF) of 0.63 per cent and a yield of 1.79 per cent.