By Hani Redha
Investors all too often fail to realise that there is more to investing in Japan than Abenomics. By solely tracking economic and political headlines, global allocators risk missing the country’s equity return potential if they ignore the micro picture.
Since 2012 Japanese equities have climbed, then corrected as economic indicators have tracked the government’s irregular progress to extricate the Japanese economy from its deep malaise, and the faith investors have put in Shinzo Abe to achieve this.
However, there is insufficient emphasis on differentiating the Japanese macro and micro themes. For instance, whilst headline figures have stalled, Japan’s earnings growth has exceeded other substantial markets over the past three years, driven by Japanese firms’ increasingly responding to shareholder needs for better returns thanks to reforms measures.
Foreign investors have likewise been encouraged by the introduction of JPX 400 index of stocks with high returns on equity. The Bank of Japan and the GPIF, the world’s largest pension fund, have supported change in corporate behaviour by purchasing JPX 400 stocks. In light of this other pension funds are expected to follow suit.
Foreign ownership trends are increasingly driving shareholder-friendly measures. Foreign owners are more likely to use their proxy votes and tend to vote more rationally, meaning that shareholder sponsored resolutions are increasingly driving corporate change.
Given voting participation levels, 35% foreign ownership can be an effective lever without the need to take a majority stake in a company, again acting as a major driver of investor friendly corporate reform.
These micro trends have been witnessed in Japanese returns on equity rising to approximately 7.2%.
Whilst a positive trend, roughly one third of Japanese companies still have a ROE of less than 5%. Focussing on profitability will be essential in order to raise these overall levels, but demonstrates the potential for Japanese equities to appreciate further as a result of effective corporate governance and stewardship.
Within this, the market is currently focused on profit margins expansion, which is necessary in the long run but requires tough decisions – returning excess capital to shareholders would appear to be the simplest and quickest fix to improve ROE.
Corporate confidence and a more active shareholder basis have resulted in raising share buybacks and dividends. However, there is still plenty of room for improvement; an estimated US$2trillion of cash is sat unproductively on corporate balance sheets – equating to 44% of GDP, this is compared with just 11% in the US.
Whilst it is unclear whether shareholder-friendliness is sustainable in the long run, the trend provides multiple opportunities for investors in Japanese equities, beyond the headline macro story.
There are plenty of opportunities across the Japanese market for active managers. The primary return drivers, improving ROE and shareholder return, will not be applied uniformly across all companies at the same pace. Markets will reward stock selection focused on companies that are expected to do more and more quickly.
Hani Redha is a senior vice president and portfolio manager, global multi-asset, at PineBridge Investments
