By Masakazu Takeda, lead portfolio manager of the Japan Focus All Cap strategy at SPARX Asset Management
The issues that have plagued Japan over the years are now at the doorstep of many developed economies. In this respect, Japan is at an advantage. However, Japan needs to continue to address these issues. At a time where Japan’s Covid-19 infections are low and its economy looks to be recovering, now may be a prime time to take a look at Japanese equities.
When it comes to change in leadership, I believe any change would not lead to large shifts in the trajectory that was set at the outset of Abenomics. Growth remains the key target for the government and its policies for Japan to get out of its deflationary economy. In terms of monetary policy, the monetisation of assets as well as further injections of liquidity into the economy are inevitable.
From a fiscal policy standpoint, as long as the economy is suffering from the pandemic, the government will not hesitate to provide further fiscal support when necessary. The new Prime Minister Fumio Kishida will bring some reforms of his own. He has backed the lifting of wages in a policy he has called a new type of Japanese capitalism. While he has yet to set out specifics, he has indicated support for higher capital gains taxes and income distribution. Depending on what policies are introduced, there may be an impact to the stock market.
Lastly, it is worth emphasising that Japan is only one of many markets in which our holdings operate. These companies will benefit if Japan is successful in pulling itself out of a slow growth scenario, but this is not a critical factor for our business’s ability to continue to perform going forward.
Corporate governance is increasing at an accelerated pace
Japan’s corporate governance reforms are starting to demand listed companies to respond to ESG. I have been receiving a lot of questions at investor relations meetings about this, and I feel that ESG awareness among listed companies is increasing at an accelerated pace.
For example, in April 2022, the Tokyo Stock Exchange will be changing the structure of the First and Second Sections into the Prime and Standard Market, respectively. In order to be listed on the Prime Market, companies will be required to have high levels of ESG factors including governance systems, human resources diversity and disclosures surrounding climate.
Communication has also been improving. Many companies have traditionally focused on analysts in charge of sectors, but more recently in an attempt to strengthen sustainability, they are increasing their dialogue with investors familiar with ESG. As a result, we have seen companies beginning to make positive changes within their management strategies and disclosure stance.
These changes are expected to become even clearer over the next one to two years in the form of strategy announcements and improvements in ESG ratings. Additionally, we believe valuations can be expected to rise as the companies become able to meet investment standards of global investors.
Demographics have been a sticking point for many years
But investing in Japan does not come without its challenges. It has long been discussed that we have a declining population due to a low birth-rate and ageing population which are major social issues here. They have been issues for a long time, and the public and private sectors have been discussing counter-measures but there is no clue to a solution. On the other hand, since the issues are already recognised, it does not mean the risks will suddenly increase.
Demographic changes can lead to investment opportunities in Japanese equities through changes in corporate attitude.
Japan took a long time to shift from the volume-chasing economic growth model that worked so well post-WWII, and one of the reasons for this is that Japanese employment practices make it difficult for companies to adjust their workforce. As a result, many companies have managed to diversify into low-profit business portfolios – the legacy which still leads to many inefficiencies throughout the economy.
In this context, a declining population makes it easier for Japanese companies to make the decision to withdraw from inefficient business segments. Narrowing down the portfolio is likely to reduce the excessive competition seen in Japan, and if the company becomes more competitive by concentrating all available resources on its core business, then it can expect to improve profitability in its global operations. I expect further improvements in corporate governance will enhance the feasibility of this scenario of improving within.
What’s next?
I am playing close attention to the growing concern around inflation. While Japan has always been on a deflationary path, it needs to be wary of the negative impact inflation can have on its economy. Indeed, the pace of price increases has so far remained low when compared with other countries.
What we need to focus on from a long-term perspective is whether the deflationary mindset of Japanese people – which has persisted since the 90s – can be changed.
If the broader economy shifts to a focus on creating more value-add while companies strengthen their ability to negotiate prices to counter inflation, this could prove a major turning point. As the value-add of a business increases, it will be easier to build supply chains that take the environment or human rights into consideration, and thus respond to the global trend of ESG compliance.
