In Japan, active investing amid mixed macro signals

15 Jun 2018

By Margaret MacCarthy Bacon, Investment Specialist

Optimism about Japan’s economic growth has become increasingly common among investment analysts, particularly since the Japanese economy is experiencing its longest period of steady economic growth since the mid-1980s. Indeed, the Bank of Japan (BoJ) expects to see solid business investment and household spending in 2018 and has raised its gross domestic product (GDP) forecast for fiscal 2018.

Since the 2012 introduction of Prime Minister Shinzo Abe’s three-pronged economic intervention program (nicknamed “Abenomics”), which focuses on fiscal expansion, monetary easing, and structural reform, the Nikkei index (Nikkei 225) has more than doubled in value. This has helped promote some positive momentum, especially for certain sectors, companies, and pockets of the economy.

However, areas of concern remain in Japan, notably the country’s aging population, high debt levels, excess cash on corporate balance sheets, uneven corporate governance, and a strong yen. Let’s look at some of these headwinds and the steps the country is taking to address them. We’ll then touch briefly on our current assessment of Japan from an equity investment standpoint.

Aging demographics. Japan’s aging population presents a headwind for economic growth and a challenge for business owners, policymakers, and investors alike. In March, the unemployment rate in Japan reached a 24-year low of 2.4%. On the positive side, the government has stepped up and enacted policies to increase labor participation rates by women and immigrants, a distinct break with the past. Women in the labor force have increased from 48% in 2012 to more than 50% currently, and foreign workers have increased by more than 40% since 2013. (Data: World Bank; Health, Labor, and Welfare Ministry — Japan).

High debt levels. As a percentage of GDP, debt levels in Japan are greater than 240%, substantially higher than the 177% found in Greece (data: Council on Foreign Relations). Nonetheless, most of the debt is owned by the BoJ and other domestic financial institutions, so the risk of defaulting is much lower than a case such as Greece, where the debt is generally held by outside entities. Consider that if the debts were not repaid, the government would simply have to recapitalize the domestic financial institutions. In a sense, Japan would be defaulting on itself. Viewed in this light, we think a default doesn’t make much sense as a likely outcome. Meanwhile, an upcoming consumption tax, set to take effect in October 2019, is meant to help decrease the debt.

Increased wages. The low employment rate noted above has raised concerns about wage inflation, which can have a negative effect on earnings. In a development that could potentially help offset this earnings pressure, the corporate tax rate in Japan was lowered from 37% in 2012 to 29.74% in April 2018. The government also enacted a tax policy that reduces corporate taxes to 25% for companies that raise wages by 3%.

Excess cash on balance sheets. Japanese companies have more than $940 billion in cash on their balance sheets, which is much higher than what we find in other developed markets (data: Goldman Sachs, via Barron’s). This detracts from return on equity (ROE). It’s worth keeping in mind, however, that the issue is not going unnoticed by the Japanese securities industry. For instance, the JPX-Nikkei Index 400, created in 2014, was meant to encourage Japanese companies to focus more on ROE. To be included in the index, companies need to rank in the top 400 on the Tokyo Stock Exchange based on ROE, operating profit, and market cap. What’s more, the effects of Abe’s reforms are already visible; ROE was at approximately 5% in 2012 and has since increased to approximately 8.4%. We believe there is room for improvement and expect more companies to focus on returning more capital to shareholders in the form of dividends and share buybacks.

Uneven corporate governance. Governance reform is a prominent issue, with companies in the Nikkei 225 exhibiting the lowest median proportion of independent directors as well as the lowest median proportion of female directors among developed-market peers, according to Bloomberg reports. On June 1 of this year, Japan's corporate governance code was revised to focus on the reduction of cross-shareholdings, greater board diversity, broader adoption of formal nomination committees, and a requirement that companies provide "clear and logical" explanations to shareholders on the allocation of management resources. We think these are important steps that could help Japanese companies become more globally competitive.

A stronger yen. A strong yen presents a disadvantage for Japanese exporters because it makes their goods more expensive and decreases the value of their overseas earnings when converted back into yen. On the plus side, however, a strong yen can strengthen a Japanese company’s purchasing power overseas. Japanese corporations can attempt to offset decreasing sales at home by increasing sales through foreign acquisitions.


Bullish at the company level, but selective

As managers of concentrated, active portfolios, we focus on the abilities of individual companies to compete in an environment of challenging macro conditions.

We believe independent, rigorous, fundamental research can uncover compelling opportunities. We are currently examining several Japanese companies that have exhibited the following traits after being put through our quantitative and qualitative screens:

  • capable management teams
  • strong balance sheets and good csh flow
  • strong competitive ositions
  • stable earnings
  • improved focus on shareholder returns
  • 50% potential upside within our 3–5 year investment horizon.


A broad opportunity set

We believe investment opportunities in Japan have some breadth to them, spanning various sectors and industries. Here are three company-level examples that help shed light on this diversity:

In the consumer sector, we own shares of a manufacturer and seller of furniture and home fashion accessories. The company is vertically integrated and able to control all major components of its business, from manufacturing to distribution to retailing. We believe this helps differentiate the firm from competitors.

In industrials, we are holding a company that specializes in making very small ball bearings. The technologies required to manufacture these components are extremely complex, so barriers to entry are high. We believe demand for bearings will grow due in part to increased use in automobiles and consumer electronics. There has also been visible pick-up in demand for bearings used in drones and other small robots.

In telecommunications, we own a telephone company whose earnings in recent years have been driven by deregulation and strong results at its regional operating companies. Its margins have improved as of late, due to cuts in subsidies and marketing expenses.


On balance, a positive view

Despite the notable headwinds that confront the Japanese economy, we strongly believe there is reason for optimism. On the whole, we think momentum in Japan is positive. In addition to constructive policy steps and an improving economy, we believe there are well-run firms that display promising fundamentals. Nonetheless, it’s important to keep headwinds in mind, and we remain highly selective when making decisions about portfolio exposure to Japanese equities.

This information is provided for general purposes only, without taking into account any potential investors’ personal objectives, financial situation or needs. It should not be relied upon by the recipient in considering the merits of any particular investment. It is not an offer to buy or sell, or a solicitation to invest in or refrain from investing in, any securities or other investment product.  Nothing in this article constitutes investment, legal, tax, accounting or other advice. The recipient should consider its own financial situation, objectives and needs, and conduct its own independent investigation and assessment of the contents of this article, including obtaining investment, legal, tax, accounting and such other advice as it considers necessary or appropriate.

IMPORTANT RISK CONSIDERATIONS

Investing involves risk, including the possible loss of principal.

Past performance does not guarantee future results.

This information is confidential and intended for the audiences as indicated below. It is not to be distributed to, or disclosed to retail investors.

The views expressed represent the Manager’s as of the date indicated, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice.

The information in this document is not, and should not be construed as, an advertisement, an invitation, an offer, a solicitation of an offer or a recommendation to participate in any investment strategy or take any other action, including to buy or sell any product or security or offer any banking or financial service or facility by any member of the Macquarie Group. The information presented is not intended and should not be construed to be a presentation of information for any U.S. mutual fund nor an offer for any product or service in any jurisdiction where it would be unlawful to do so. This document has been prepared without taking into account any person’s objectives, financial situation or needs. Recipients should not construe the contents of this document as financial, investment or other advice. It should not be relied on in making any investment decision.

Future results are impossible to predict. This document contains opinions, conclusions, estimates and other forward-looking statements which are, by their very nature, subject to various risks and uncertainties. Actual events or results may differ materially, positively or negatively, from those reflected or contemplated in such forward-looking statements. Past performance information shown herein, is not indicative of future results.

This presentation does not contain all the information necessary to fully evaluate any investment program, and reliance should not be placed on the contents of this document. Any decision with respect to any investment program referred to herein should be made based solely upon appropriate due diligence by the prospective investor. The investment capabilities described herein involve risks due, among other things, to the nature of the underlying investments. All examples herein are for illustrative purposes only and there can be no assurance that any particular investment objective will be realized or any investment strategy seeking to achieve such objective will be successful.

No representation or warranty, express or implied, is made as to the accuracy or completeness of the information, opinions and conclusions contained in this presentation. In preparing this presentation, reliance has been placed, without independent verification, on the accuracy and completeness of all information available from external sources.

The following registered investment advisers form part of Macquarie Group’s investment management business, Macquarie Investment Management: Macquarie Investment Management Business Trust, Macquarie Funds Management Hong Kong Limited, Macquarie Investment Management Austria Kapitalanlage AG, Macquarie Investment Management Global Limited, Macquarie Investment Management Europe Limited, and Macquarie Capital Investment Management LLC.

Other than Macquarie Bank Limited (MBL), none of the entities noted in this presentation are authorised deposit-taking institutions for the purposes of the Banking Act 1959 (Commonwealth of Australia). The obligations of these entities do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of these entities, unless noted otherwise.

Diversification may not protect against market risk.

For recipients in the United States, this document is provided by Macquarie Investment Management Business Trust (MIMBT). Institutional investment management is provided by Macquarie Investment Management Advisers (MIMA), a series of MIMBT. MIMBT is a U.S. registered investment advisor, and may not be able to provide investment advisory services to certain clients in certain jurisdictions.

For recipients the European Economic Area, this document is a financial promotion distributed by Macquarie Investment Management Europe Limited (MIMEL) to Professional Clients or Eligible Counterparties defined in the Markets in Financial Instruments Directive 2004/39/EC. MIMEL is authorised and regulated by the Financial Conduct Authority. MIMEL is incorporated and registered in England and Wales (Company No. 09612439, Firm Reference No. 733534). The registered office of MIMEL is Ropemaker Place, 28 Ropemaker Street, London, EC2Y 9HD. The investment capabilities described herein are managed by MIMEL, with day-to-day management responsibilities sub-delegated to relevant affiliated managers.

This document has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

For recipients in Switzerland, this document is distributed by Macquarie Investment Management Switzerland GmbH. In Switzerland this document is directed only at qualified investors (the “Qualified Investors”), as defined in the Swiss Collective Investment Schemes Act of 23 June 2006, as amended (“CISA”) and its implementing ordinance.

For recipients in Australia, this document is provided by Macquarie Investment Management Global Limited (ABN 90 086 159 060 Australian Financial Services Licence 237843) solely for general informational purposes. This document does not constitute a recommendation to acquire, an invitation to apply for, an offer to apply for or buy, an offer to arrange the issue or sale of, or an offer for issue or sale of, any securities in Australia. This document has been prepared, and is only intended, for ‘wholesale clients’ as defined in section 761G of the Corporations Act and applicable regulations only and not to any other persons. This document does not constitute or involve a recommendation to acquire, an offer or invitation for issue or sale, an offer or invitation to arrange the issue or sale, or an issue or sale, of interests to a ‘retail client’ (as defined in section 761G of the Corporations Act and applicable regulations) in Australia.

For recipients in PRC, Macquarie is not an authorized securities firm or bank in the People’s Republic of China and does not conduct securities or banking business in the People’s Republic of China.

For recipients in Hong Kong, this document is provided by Macquarie Funds Management Hong Kong Limited (CE No. AGZ772) (MFMHK), a company licensed by the Securities and Futures Commission for the purpose of giving general information in relation to the strategy(ies) described herein. The information contained in this presentation is provided on a strictly confidential basis for your benefit only and must not be disclosed to any other party without the prior written consent of MFMHK. If you are not the intended recipient you are not authorised to use this information in any way. This presentation does not, and is not intended to, constitute an invitation or an offer of securities, units of collective investments schemes or commodities (or any interests in any index thereof) for purchase or subscription in Hong Kong. The information in this presentation is prepared and only intended for professional investors and not to any other person. This presentation has not been approved or reviewed by the Securities and Futures Commission.

For recipients in Korea, this document is provided at the specific request of the recipient who is a person specified under Article 101(2) of the Presidential Decree of the Financial Investment Services and Capital Markets Act (Act) without any solicitation by Macquarie. Therefore, this document may not be distributed, either directly or indirectly, to others in Korea. The person receiving this document represents and warrants that if it receives this document, it is a professional investor as defined under the Act. No member of the Macquarie Group makes any representation with respect to the eligibility of any recipients of this presentation to acquire the products or services therein under the laws of Korea, including but without limitation the Foreign Exchange Transactions Act and Regulations thereunder. The products and services have not been registered under the Act, and none of the interests may be offered, sold or delivered, or offered or sold to any person for re-offering or resale, directly or indirectly, in Korea or to any resident of Korea except pursuant to applicable laws and regulations of Korea.

For recipients in Malaysia, Taiwan, The Philippines, this document is provided at the specific request of the recipient.

For recipients in Singapore, the Strategies which are the subject of this document do not relate to a collective investment scheme which is authorised under section 286 of the Securities and Futures Act, Chapter 289 of Singapore (the “SFA”) or recognised under section 287 of the SFA.  The Strategies are not authorised or recognised by the Monetary Authority of Singapore (the “MAS”) and shares are not allowed to be offered to the retail public.  Each of this document and any other document or material issued in connection with the document is not a prospectus as defined in the SFA. Accordingly, statutory liability under the SFA in relation to the content of prospectuses would not apply. You should consider carefully whether the investment is suitable for you. This document has not been registered as a prospectus with the MAS. Accordingly, this document and any other document or material in connection with the offer or sale, or invitation for subscription or purchase, of shares may not be circulated or distributed, nor may shares be offered or sold, or be made the subject of an invitation for subscription or purchase, whether directly or indirectly, to persons in Singapore other than (i) to an institutional investor under Section 304 of the SFA, (ii) to a relevant person pursuant to Section 305(1), or any person pursuant to Section 305(2), and in accordance with the conditions specified in Section 305 of the SFA, or (iii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA.

For recipients in Japan, this document is provided by MFMHK. MFMHK is supported by Macquarie Asset Management Japan Co., Ltd., a Financial Instruments Business Operator: Director General of the Kanto Local Finance Bureau (Financial Instruments Business) No.2769 (Member of Japan Investment Advisers Association). This presentation does not, and is not intended to, constitute an invitation or an offer of securities in Japan. The securities have not been and will not be registered under the Financial Instruments and Exchange Act of Japan. None of the securities may be offered or sold, directly or indirectly, in Japan or to, or for the benefit of, any resident of Japan (which term means any person resident in Japan, including any corporation or other entity organized under the laws of Japan), or to others for re‐offering or resale, directly or indirectly, in Japan or to a resident of Japan, except pursuant to an exemption from the registration requirements of, or otherwise in compliance with, the Financial Instruments and Exchange Act of Japan and in compliance with any other applicable laws and regulations of Japan.

Macquarie Group, its employees and officers may act in different, potentially conflicting, roles in providing the financial services referred to in this document. The Macquarie Group entities may from time to time act as trustee, administrator, registrar, custodian, investment manager or investment advisor, representative or otherwise for a product or may be otherwise involved in or with, other products and clients which have similar investment objectives to those of the products described herein. Due to the conflicting nature of these roles, the interests of Macquarie Group may from time to time be inconsistent with the Interests of investors. Macquarie Group entities may receive remuneration as a result of acting in these roles. Macquarie Group has conflict of interest policies which aim to manage conflicts of interest.

All third-party marks cited are the property of their respective owners.

© 2018 Macquarie Group Limited

June 2018

ID# [509176] 1

This information is a general description of the Macquarie Group only. Before acting on any information, you should consider the appropriateness of it having regard to your particular objectives, financial situation and needs and seek advice. No information set out above constitutes advice, an advertisement, an invitation, a confirmation, an offer or a solicitation, to buy or sell any security or other financial, credit or lending product or to engage in any investment activity, or an offer of any banking or financial service. Some products and/or services mentioned on this website may not be suitable for you and may not be available in all jurisdictions. All securities and financial products or instrument transactions involve risks. Past performance of any product described on this site is not a reliable indication of future performance.

Important Information

Investment Management

The material and information on this web page and the web pages accessed through this web page (together, the "website") is for distribution only to persons who are not a retail client (defined by section 761G of the Corporations Act 2001 of Australia) and who are sophisticated investors, professional investors or other investors who do not require disclosure under Part 6D.2 of the Corporations Act 2001 of Australia. If you access this website, you are confirming you are entitled to do so under all applicable laws, regulations and directives in all applicable jurisdictions.

By proceeding to access the pages on this website, you agree and confirm that: 

  • You have read, understood and accept the above disclaimer;
  • Your access to this website does not violate applicable laws, including the laws of your home jurisdiction;
  • You are not a "retail client" within the meaning of the Corporations Act and agree not to disclose the information to a person who would be a "retail client"; and
  • You are either: (a) not a “U.S. person” as that term is defined in Regulation S under the US Securities Act of 1933 (the “US Securities Act”), are not in the United States, and are not acting for the account or benefit of a U.S. person, (and you will not make a copy of any prospectus or any other material contained on this website available to, or distribute a copy of such prospectus or other material to, any such U.S. person) or (b) a “qualified institutional buyer” as that term is defined in Rule 144A under the US Securities Act.

If you access this website, you are confirming that you are entitled to do so.