Look beyond the Olympics for long-term value in Japan
- Japan has suffered from an increase in Covid-19 infections, a corporate scandal and the uncertainty of the Olympics
- Relatively low valuations and well-capitalized companies make parts of the Japanese stock market still attractive
It has been a disappointing year for Japan. Questions remain about the Olympics set to begin on July 23, after Tokyo was placed on a state of emergency in April amid rising Covid-19 cases. A poll in May found that 60% of the Japanese public did not want the games to take place, foreign viewers were excluded and domestic viewers capped at 10,000 per venue. The number of Covid-19 infections in Japan has increased as the situation in the United States and Europe has improved, and Japan is clearly behind other developed markets with its vaccination program.
These factors have led the Japanese stock market to lag behind others during the recent rally in cyclical stocks. For example, over the past three months, the MSCI UK index has risen 7.5% while the MSCI Japan has only risen 1%.
Rob Morgan, chief analyst at wealth manager Charles Stanley, adds that if inflation rises further it could become a problem for some companies, with rising input prices causing pressure on margins and supply shortages, for example in semiconductors for the automotive industry. “These will affect various companies and sectors in different ways, but for exporters with high input costs and relatively low margins, this could be a significant problem,” he explains.
Look ing forward
Despite a few difficult months, there is reason to be optimistic about long-term investment opportunities in Japan. Companies that would have benefited from the Olympics, such as those in the tourism sector, have already had bad news factored into their share price. And although the vaccine rollout has been slow, Tomo Kinoshita, global market strategist at Invesco Asset Management, says the government has now contracted enough supplies to accelerate the rollout, which he says should boost the vaccination rate. 50% by September. .
“I see an advantage for stocks focused on domestic demand,” says Kinoshita. “I also believe that stocks in Japan’s capital goods sector will outperform, as capital investment is likely to pick up globally due to pent-up demand and demand for digital transformation and emissions controls. digital carbon. “
Jim McCafferty, head of Asia (ex-Japan) research at Nomura, said another short-term factor that could boost the stock market is that the earnings season in Japan has been increasingly “crowded” with many companies reporting in particular on May 14th. He believes investors haven’t been able to fully digest the fact that results have been strong due to this unusual overcrowding in reporting deadlines.
While a pickup in inflation is a concern for many equity investors, especially those with long-lived growth stocks, many Japanese companies could do very well if and when inflation picks up there. . Sectors such as machinery may benefit from a pickup in global inflation as a result of increased capital spending. McCafferty says that Komatsu (JAP: 6301), a global manufacturer of construction, mining and utility equipment, is an example of a company that could do well.
Simon Edelsten, co-manager of Artemis Global Select Fund (GB00B568S201) and Mid Wynd International Investment Trust (MWY), says companies such as Nippon Telegraph and Telephone (9432: TYO), which has not been able to increase telephone rates for 20 years, could benefit from modest inflation. But despite a pickup in US inflation and a rebound in commodity prices, Japanese inflation remains low at 0.96 percent.
Japan also has many financial stocks that could benefit from a vibrant global economy, and its large auto industry is well positioned to benefit from a recovery in global trade and capital spending. However, Morgan points out that companies with limited pricing power, perhaps because they have less technological advantage, will have a harder time passing on higher input costs. A “roaring twenties” inflationary scenario is therefore unlikely to be good for all businesses.
The long-term reasons for investing in Japan remain. The valuations of Japanese equities are attractive compared to other markets: for example, the forward price / earnings ratio of the MSCI Japan Index is 16.37x against 19.73x for the MSCI World and 21.96x for the MSCI USA indices.
Japan is also attractive to those looking for a reliable source of income. More than half of Japanese companies have net liquidity on their balance sheets compared to 10 to 20 percent in Western developed markets. Although the MSCI Japan dividend yield is quite low at 2%, Japanese dividends only fell 5.6% last year while UK dividends fell 40%, according to the Janus Henderson Index Global Dividend. On average, Japanese companies pay only one-third of profits as dividends, so there is significant scope for payments to increase over time.
Japanese companies were seen as established in their ways and not prioritizing shareholder returns enough, but Morgan says “this is slowly changing.” The number of activist funds in Japan seeking to extract hidden value is increasing, which should help shareholder capitalism. However, a recent and damning investigation into Toshiba (JAP: 6502) which showed the government stepped in to help its management fend off investor challenges has called into question the credibility of Japanese business reforms.
Funds for Japan
For investors looking to play on the prospect of a cyclical equity rally, Morgan suggests Men GLG Japan CoreAlpha (GB00B0119B50). This fund applies a contrarian, value-driven approach to the Japanese market where some of the lower valuations can be found. He has a concentrated portfolio of stocks in old-fashioned areas that have underperformed but remain resilient companies.
The fund is not suitable for all market environments, for example when investors favor certainty of earnings over cheap valuations, which is why it has underperformed the TOPIX index for the past five years. However, with over 30 percent of the fund in banks and transportation equipment, it has significantly outperformed over the past year as value-oriented investing styles have been more successful.
Morgan says, “Over time supporting good stocks in less fashionable areas has been very successful, and managers have a very consistent, patient and robust process around this which is vital. It would pair very well with a fund that targets more growth oriented areas, as they would have little to no overlap in terms of underlying positions. “
Baillie Gifford Shin Nippon (BGS) is a good way to gain exposure to fast growing and disruptive Japanese small companies. The investment trust owns 40 to 80 stocks in a wide range of industries. Although its benchmark, the MSCI Japan Small Cap Index, includes around 900 companies, the trust managers only look at around 200 companies because they believe the others are insufficiently liquid or in mature sectors without sufficient growth potential.
Although the valuations of small Japanese companies are significantly higher than those of large-cap Japanese cyclical companies, they remain below those of their peers in other markets. Baillie Gifford Shin Nippon manager Praveen Kumar adds that Japanese small caps are under-sought, giving his team yet another opportunity to spot long-term growth opportunities.
The trust has a fantastic long term performance record, but hasn’t done as well as the market environment has changed. However, this has resulted in a narrowing of the premium to the net asset value it is trading on. That figure hit double-digit levels last year, but was only 0.3 percent on June 17.
If you are looking for a basic Japanese fund, Lindsell Japanese Stock Train (IE00B7FGDC41) provides exposure to some of the biggest and best companies in Japan. For example, his top 10 holdings include Nintendo (JAP: 7974) and Takeda Pharmaceutical (JAP: 4502). The fund is managed by Michael Lindsell and focused on just 20-35 holdings, companies with sustainable business models and established brands. Lindsell is looking for companies with long term sustainability in generating profits, which tends to lead it towards branded consumer goods, internet, media, software, pharmaceutical and financial companies. Although the fund has not performed well over the past six months, its long-term performance is excellent.
|Fund / benchmark||1 year (%)||3 years (%)||5 years (%)||10 years (%)|
|Baillie Gifford Shin Nippon (stock market price)||23.52||15.11||113.69||640.32|
|Lindsell Japanese Stock Train||-7.73||0.26||74.63||215.82|
|Men GLG Japan Core Alpha||19.43||0.21||59.38||125.29|
|MSCI Japan Index||11.44||15.38||70.93||145.24|
|MSCI Japan Small Cap Index||7.47||2.83||59.39||170.93|
|TSE TOPIX Index||10.87||11.92||68.57||149.58|
|Source: FE Analytics, 06.17.21. Performances shown in pounds sterling, total cumulative returns|