Looking beyond ‘Japain’
Why bother allocating to Japan? This is a question that many pension funds might ask themselves given the seemingly secular Japanese equity bear market that has persisted since the early 1990s. The current economic climate barely allows for optimism either for the global or the Japanese economy.
Other auguries have also not favoured Japan: last month Masaaki Shirakawa, the new governor of the Bank of Japan (BoJ), warned that the economy was subject to downside risks. Interest rates remain at 0.5% and memories of deflation persist, even if the economy has now moved into positive inflationary territory.
Indeed, political wrangling this spring over the appointment of the governor of the Bank of Japan added to the ‘Japain' epithet - although that situation has now been resolved following Shirakawa's appointment. But still, the ruling Liberal Democratic party's loss of control of the upper house to the Democratic Party of Japan (DPJ) last July has only served to create a general sense of political uncertainty to add to economic woes. Indeed, it was the DPJ's manoeuvring in the upper house that led to the impasse over the appointment of the central bank governor.
Overall, the MSCI Kokunai Investable Market 1500 index of Japanese shares has performed positively over the three Japanese financial years to 31 March 2008, notching up 8.24% over the period, or a rather unimpressive 2.75% annualised. This may be acceptable for local institutional investors with low return expectations, but is not ideal for those investing from the west.
But Morikazu Fukui (pictured above right) and Masataka Hama, Pictured below left) co-CEOs of DIAM, the investment firm owned by Mizuho Financial Group and Dai-ichi Mutual Life Insurance, claim that this is a good time for European investors to invest in Japan - despite the economic woes and rocky performance of Japanese stock indices in recent months and years. The co-CEOs think that Japanese stocks are now cheap, that longer term economic indicators will be benevolent and that corporate governance is improving. They also point to positive developments such as the privatisation of the Japanese Post Office last October, as well as to other factors such as the appreciating yen.
The message is simple: "Our view is that Japanese equities are undervalued," says Hama. "For instance, if you look at the price-to-book ratio of the stocks on the Tokyo Stock Exchange, over 50% of shares are at a level below one. And also although Japanese companies are offering low annual dividends, the dividend rate is around 1.6-1.7% and that is above the BoJ real interest rate. Japanese equities will bounce back and even last year we saw a lot of interest, for example from European pensions, oil money or sovereign wealth funds. Equities were very cheap last year."
"We have also been recommending to investors that this is a good time to jump in," adds Fukui. "Our team, including fund managers in Tokyo, recently had an investors meeting in various places in Europe, and a positive response from investors. We have been seeing gradual inflows. Investors may be sharing this idea that the Japanese are positive and that it is time to invest. Maybe the economy will be difficult but there is positive movement."
Hama also points to the currency effect of the appreciating yen, which will have worked in investors' favour recently. He says: "Although the yen has increased this year there is scope for it to increase further and the interest rate differential will go down. The yen has been undervalued for several years and we will probably see a stronger yen in the coming months."
Despite all this, corporate governance is perceived by European investors to be Japan's weak point. Those actively engaging with Japanese companies note that despite the polite reassurances, it is difficult to get firms to commit to change.
A report published last month by the Asian Corporate Governance Association (ACGA) in Hong Kong concluded that in most listed Japanese companies the system of governance is failing to meet the needs of shareholders - in terms of supervision of corporate strategy, by shielding managers from market disciplines and by failing to provide sufficient returns for Japanese pension funds. The document, which was prepared with the support of European institutional investors including Aberdeen Asset Management, F&C, Hermes and Railpen, recommended action in a number of areas, including poison pill takeover defences and independent management supervision.
For their part, Hama and Fukui are more bullish on governance and say things are starting to change. "Looking back more than 10 years, cross holdings were the norm for all Japanese companies but because of the Japanese banking problems they dramatically sold their shareholdings as they could not manage that key risk in terms of volatility," says Hama.
"Most of those companies' major shareholders have changed so we have more foreign shareholders and pension sponsors as shareholders," he continues. "However, especially since last year or the year before, we see companies that are wishing to prevent hostile takeovers that put up defences. In terms of cross shareholdings, although some companies have started to promote this, it is still limited among Japanese companies and now I believe they cannot survive without proper governance and proper attention to other shareholders.
"I think it is almost impossible to reverse that kind of trend because foreign investors are already quite important. It is for the management to listen to reasonable requests from investors and it will be good for institutional investors if they promote shareholder value."
Hama also points to Nippon Sheet Glass, which bought Pilkington, and which has a British president and CEO - Stuart Chambers. Nissan's CEO is of course the Brazilian born Carlos Ghosn and Sony's is Sir Howard Stringer. "I think Japanese companies are slowly changing their management otherwise it is almost impossible to survive," concludes Hama.
"Nissan has done a good turnaround although Honda not exceptionally so. Many companies are global companies and I have no doubt about their management. They are increasing shareholder value and I think that this will probably be a trend impossible to reverse."
Beyond politics and the macro-economic framework, the DIAM CEOs again emphasise that investors are now taking a pragmatic view on Japanese stocks.
"We are receiving enquiries from European investors because they take the view that Japanese equities are undervalued," says Hama. "But we also have Japanese investors who put money into Japanese shares. Japanese pension investors are still buying Japanese equities - they have balanced funds and these mandates have a certain allocation to Japanese equities."
Overall, DIAM has set itself the goal of becoming an asset manager with a more expansive reach, and Europe is part of that goal, as well as Asia. "Our three-year business plan is for DIAM to become a global asset manager with a focus on Europe," says Fukui. But DIAM has managed money for some time for oil producing clients within relationships engendered through the former Industrial Bank of Japan, which combined with Fuji Bank and Dai-ichi Kangyo Bank in 2002 to form the Mizuho Financial Group.
The asset management firm has also recently opened a research office in Hong Kong and is planning to open an office in Singapore this year. "We are thinking of expanding in Asia in two ways," says Hama. "We would like to sell our investments to Asian investors. We would also like to manage Asian equities for Japanese clients. We have been running these areas from Tokyo but we will be sending portfolio managers to local offices.
"Japanese investors are getting more interested in these emerging countries in Asia. The Japanese are very keen to diversify so they have already started to invest in new areas such as India and China," continues Hama.
Fukui adds that DIAM already runs a China equity fund for a French retail distributor. "We want to develop this area," he says.