Capturing value opportunities
It seems almost inexplicable to suggest the equity market of the third-largest economy in the world is overlooked and under-researched, but that is unquestionably still the case. Most global equity managers have a structural underweight to Japan, and they are quick to dismiss it as characterised by slow growth and lowly returns.
Also, with growth having been in the spotlight for two decades, value opportunities are still frequently over looked by the broader market, and especially those with long memories of ‘value traps’.
To combat this perception, investment in today’s Japan must begin with ensuring value traps are avoided, and by creating the environment wherein true long-term value can be discovered. To be successful, a combination of ‘horizontal’ and ‘vertical’ research must be employed.
Blending horizontal and vertical research
Horizontal research – the accumulated knowledge of Japanese companies and industries – is essential to identifying value companies and unlocking value.
Context is key. Having a historic understanding of Japanese companies provides insights that can help to determine:
- Why the company is trading at a low valuation, within a broader context
- The quality of management
- Balance sheet strength
- Non-financial information not yet priced-in by the market, but indicative of future earnings and cash flow generation
All of these, and more, can offer signals for a potential catalyst leading to positive change.
However, to access information beyond financial statements, sell-side research, and local news flow, an on-the-ground presence is needed. A vertical research approach can deliver invaluable insights that help put into context the idiosyncratic risks of individual companies and sectors.
In vertical research, questions can be asked that only individuals with a real-world and real-time knowledge of the organisation can answer. Therefore, when meeting companies it’s important to not just meet with senior management, but with its employees throughout the organisation, from product developers to factory floor workers. Not only can vertical research help to deepen an understanding of a company, including opportunities and risks, it can also strengthen the relationship with senior management, introducing insights and observations that can be used to inform, educate and change the company from within.
Relationship building
One of the fundamental advantages of a value-driven approach to Japanese equities, is that it complements the new corporate environment being built in Japan. Trust remains a highly valued currency in Japan, and at its core, value investing aims to develop and maintain deep and lasting relationships with companies – across all levels of its corporate structure – to build high conviction positions. Although the relationship between Japanese companies and shareholders has become more demanding, and more contentious, at times, the relationships that these companies foster with investment managers can be more constructive, with the investment managers occupying the middle ground between the company and other shareholders.
Summary
Whereas Japan’s equity markets were historically under cut by weak institutions and brittle governance, the opposite is true today. Japan has learned that corporate reform and strong governance is an evolutionary process, and equity markets are now firmly underpinned by the country’s more mature economic foundations.
The long-awaited turnaround in Japanese equities is still in its early stages, but the momentum is building. As structural changes encouraging better corporate governance and increased shareholder engagement continue, Japanese companies will continue to experience catalysts that unlock hidden value. In this type of market, applying a value-oriented investment approach can be extremely effective in delivering stable, long-term returns, especially when compared to a momentum-led approach.
