2021 has been an exciting year so far for the Japanese market says Richard Aston, portfolio manager of the CC Japan Income & Growth Trust, and that includes attractions for income seekers too.
The Nikkei 225 breached the 30,000 mark for the first time in nearly 31 years in February. Today, at the end of April, it continues to sit far above the lows of around 16,500 it hit during the throes of the initial waves of the coronavirus pandemic last year.
As with many global indices, buying momentum has arisen in the face of the development and roll-out of Covid vaccines nationwide. But in Japan, sentiment has been lifted in-part by strong economic data and better-than-expected corporate performance amid tough market conditions leading to increased buying of “undervalued” Japanese stocks by foreign investors.
But while value investors are now capitalising on Japan’s tremendous resilience in the face of adversity, the allocation to the nation in global equity indices continues to only sit at around 8%.
By overlooking Japan in this way, we believe that these investors are missing out on some of the strongest dividend growth opportunities in today’s markets.
One reason income investors may be hesitant to invest in Japan is the decades of ineffective corporate governance. But this view is now dated – corporate governance has been improving in the country for years. Japan’s Corporate Governance Code of 2015 (along with its subsequent revisions), put into motion a structural change that continues to gain traction across the corporate landscape.
In fact, corporate governance was one of the core tenets of former Prime Minister Shinzo Abe’s tenure. Over his years in charge, he introduced a swathe of new codes and guidelines reforming how companies are run and how shareholders are remunerated.
The signs suggest the reforms have made an extremely positive impact.
Japan enjoyed its fifth consecutive year of world-beating dividend growth in 2019, while share buybacks have also been increasing during the same five years.
This direction of travel is poised to last well into the future as new Prime Minister, Yoshihide Suga, has pledged to continue Abe’s corporate governance reforms with the hope of continuing to improve outcomes for shareholders and attracting more foreign investment. Likewise, the Japanese Financial Services Agency has now started discussing upcoming revisions to the nation’s Corporate Governance code to put further pressure on companies to disclose their conformance with its requirements.
Many companies across the West cut dividends last year as they were forced to use excess cash to cover revenue shortfalls or faced regulatory pressure to do so. Some estimates put the total value of global dividend cuts between the second and fourth quarters of 2020 at US$220 billion.
More than half of companies listed on the Topix have net cash in reserve. This compares to fewer than 15% on the S&P 500 and around 21% on the FTSE All-Share.
This cash, has helped provide dividend cover throughout the pandemic and while many Western companies were cutting dividends last summer, around 60% of Japanese firms planned to leave them unchanged compared with the same period in the prior year.
A recent report from Daiwa Securities highlights the fact that Japanese dividends have been considerably more robust than earnings in FY20.
Its analysis showed that the constituents of the Topix 500 are likely to report a net income down over 20% in FY20 compared to FY19. However, despite this, the reduction in aggregate dividends is now forecast to be around 4%.
The bigger picture
A further reason for income investors’ potential reluctance to engage with Japan could perhaps also be the most significant.
Many of Japan’s largest and most influential stocks are members of what could be termed the “old guard”. For these firms, transitioning towards a pro-shareholder model with an emphasis on returns and activist influence is much harder than it is for new upstarts.
The overall impact is that these companies lower the average dividend yield of the Japanese market as a whole. In so doing, investors with certain minimum yield hurdles to meet might see Japan falling off their radars.
If this is the case, these investors may be missing the opportunity that lies within.
It’s important to view the bigger picture when it comes to Japan as an increasing number of “new guard” stocks are providing well-covered dividends growing at world-beating rates. Making the most of them is just a case of picking the right portfolio.
From talking to the firms in which we invest throughout the pandemic, it became clear that shareholder returns are now an ingrained part of their thinking.
With Japanese stocks presenting some of the world’s strongest and fastest-growing dividend opportunities, we believe that income investors can no longer afford to ignore the nation as a whole.
Richard Aston is portfolio manager of the CC Japan Income & Growth Trust