The investment spotlight is beginning to shine on Japan once again, as a plunging yen and continued signs of elusive inflation heighten the appeal of this often-overlooked economy. With the Bank of Japan staunchly refusing to raise rates, despite producer prices rising to the highest level in 41 years in April, investors are waiting to determine whether a weaker currency will trigger an influx of foreign investment and reignite Japan’s anaemic economic growth.
However, while the current focus is firmly on the implications of yen weakness, there is a far more compelling wider picture emerging in Japan. The country is undergoing a remarkable turnaround, with improving demographics, widespread corporate governance reforms and ESG awareness all combining to power productivity and corporate earnings. For investors willing to dig deeper into the Japanese dynamics, there is a wealth of untapped potential on offer.
Historically, Japanese corporate culture has been associated with hierarchy and lifetime loyalty. Dominated by a few conglomerates or keiretsu, and revered longstanding entities known as shinise, Japanese corporates have been slow to adopt tech, which has stifled start-up innovation – a polar opposite to the backdrop in the US. With decades of deflation and a feeble economy, it is not surprising investors have looked elsewhere for high-growth stocks.
But the Japan of today is not the Japan of ten years ago, and the country has undergone quite a revival. Although Japan is well known for its ageing population, the retirement of baby boomers in the last several years has brought with it a welcome change of strategy for management teams. Companies previously felt obligated to maintain high levels of employment – even when productivity was suffering – but there are now signs of flexibility and an emphasis of value over volume.
The advent of the Japan Stewardship Code in 2014, which transformed corporate governance, also delivered a profitability boost. More recently, Prime Minister Fumio Kishida has been promoting a form of ‘new capitalism’, which focuses on the distribution of wealth – not just the creation. Corporates are now prioritising sustainable growth, and last year we saw Japanese companies boost capex and add jobs.
We recently added Hitachi, one of Japan’s oldest electric machinery and heavy industrial equipment manufacturers, to our portfolio. After recording major losses during the 2008 financial crisis, the company went through numerous restructurings and has since significantly boosted profitability. We see even further improvements ahead, as Hitachi transitions from a manufacturing-driven hardware sales model to a scalable asset-light, solution-based business. Hitachi serves as an example of the changes underpinning many companies across Japan.
Bright future ahead
While it has been decades since Japan was home to the world’s most innovative corporate icons, investors should not discount the strong upside potential as a result of ongoing productivity and sustainability tailwinds. We would not be surprised to see return on equity surpass 10% as Japan catches up to international standards.
Japan is also gaining ground on ESG. Recent revisions to the Stewardship Code now require companies to disclose carbon emissions and reinforce board-level independence and measures of diversity. In April, the Tokyo Stock Exchange also changed its company classifications from first, second and third to prime, standard and growth, with stricter ESG standards for the coveted prime listings.
While the leaders in ESG adoption may not offer much upside after strong share price gains, we see tremendous potential in a range of ESG improvers, and are working closely with management teams to enhance practices.
We recently invested in Horiba, the world’s leading provider of instruments measuring and analysing automobile exhaust gas, which is also developing new business lines related to hydrogen technology. Most companies trialling hydrogen tech are fossil fuel led, so this is a rare opportunity to back a totally clean energy enterprise.
We also took a position in Toyota Motor last year after it ramped up its sustainability activities. Toyota is also active in hydrogen, already selling over 15,000 units of fuel cell vehicle. The car manufacturer has a technological advantage in this space, as it can easily adapt its supply chains away from combustion motors and into clean fuel engines.
For investors willing to renounce preconceived notions on corporate Japan and open their eyes to the ongoing progress on display, the opportunities on offer in the Land of the Rising Sun will prove to be more than just another false dawn.