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Keeping an active interest in Japan

  • 16Nov 16
  • Hugh Young Managing Director of Aberdeen Asia

Faith in Abenomics is fading fast if Japan’s stock prices are any gauge of investor confidence.

The benchmark Topix index, which tracks 1,969 companies, has fallen over 12% since the start of this year, with the decline extending to almost 20% from last August, when the index hit its highest levels following Prime Minister Shinzo Abe’s announcement of his economic revival plan.

The yen’s 16% surge against the dollar this year has curtailed the earnings of companies in the export-sensitive Topix; stimulus measures have failed to boost domestic demand; the country is no closer to the 2% inflation target set by the Bank of Japan (BoJ) in January 2013.

The central bank’s controversial experiment with negative interest rates seems to have backfired: companies that have been hoarding cash for years aren’t inclined to borrow and invest no matter how cheap money is. Meanwhile, banks suffer as lending margins are squeezed even more.

Investors haven’t been impressed. Foreigners, in particular, have been pulling money out of the market. They are on track for their biggest annual exodus from Japanese stocks since 1987, according to data compiled by Bloomberg.

Share losses might have been steeper if not for the asset buying programmes of the Government Pension Investment Fund and the central bank. In September, the BoJ shifted its purchases of exchange-traded funds (ETFs) in favour of instruments that track the Topix. It had previously bought ETFs tracking the Nikkei 225 index.

This switch at least has the merit of being less distorting. The Topix, unlike the Nikkei, is an index weighted by market capitalisation, tracking almost nine times the companies of the Nikkei. Still, stimulus-related buying has magnified the trend toward passive investing, which is now a global phenomenon.

Passive approaches are especially popular with global asset allocators, who seek diversification by investing in Japan, although not to the same level as the country’s MSCI1 World Index weight (currently around 9%).

Should we, as active investors, care about these developments? There is a lively debate today about the effects of passive buying. In Japan’s case, there is clearly scope for second guessing where stimulus money will end up.

A falling market will eventually make plain where true value resides.

However, we are a long way from a situation where passives become the market, leaving active investors sidelined. A falling market will eventually make plain where true value resides.

As it stands, the world’s fourth-largest equity market plays to the strengths of the diligent stock picker: there are more than 3,500 listed companies. Of the almost 2,000 in the Topix, nearly one third are not covered by analysts. Do some digging and you will find interesting prospects.

Furthermore, while limited free floats may hamper liquidity, the better companies now have the cash to pick off rivals or to invest in themes such as an ageing society, offshoring and convenience. These are not new themes, but they are creating new business and investment opportunities.

By pushing through stewardship and government codes, policymakers are keen for investors to reward well-run companies. Just don’t expect wholesale conversion to more non-executive directors or votes on remuneration. Companies that learned hard-won lessons about fortitude and resilience during two decades of economic stagnation care little about how they present themselves to shareholders.

Japan’s prosperity owes more to enterprise than government handouts or currency devaluation.

It was considered a radical move a generation or two ago for companies to move operations overseas to pursue new markets and lower production costs. Today, it seems obvious that firms follow customers, often to faster-growing emerging markets where they can best tap changes in global consumption.

For example, Japan Tobacco enjoys a dominant domestic market share but also boast sales in 120 countries worldwide; share dividends have grown more than 3.5 times in five years.

So as Abe limbers up for another round of fiscal stimulus and the BoJ ‘doubles down’ on its monetary bets, the focus will remain on macro policy experimentation. Here Japan is on the frontline: not just in testing the limits of what quantitative easing can do, but also managing a decline in national wealth as society ages. This is a structural more than a cyclical problem – and a failure to understand that distinction may be one reason why policies are not working.

A post-Brexit Britain should pay attention. Japan’s prosperity owes more to enterprise than government handouts or the temporary advantage of currency devaluation. Its leading companies, big and small, are bywords for product and process excellence, and skilled at managing costs and supply chains. They also have a long-term perspective. That is why the country remains a market worth investing in.

1Morgan Stanley Capital International

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