The Case for Investing in Japan
The article below is from our BRIEFINGS newsletter of 28 October 2019
Despite Japan’s aging population and mounting public debt, the country offers a host of investment opportunities, according to Katie Koch, co-head of Goldman Sachs Asset Management’s (GSAM) Fundamental Equity business. Koch recently returned from GSAM’s annual Investor Tour, held this year in Tokyo and Kyoto, where the team hosted 20 CEOs, CIOs and heads of equity from large global institutions along with Japanese policy makers, government officials and C-suite executives.
Katie, why did you elect to go to Japan for this year’s Investor Tour?
Katie Koch: Japan is changing incredibly rapidly, but it continues to be misunderstood and, for the most part, underappreciated by investors. Indeed, Japan is the only major global equity market that has actually had a de-rating in its price-to-earnings multiple since the global financial crisis. This is despite dramatic improvements in corporate governance and the fact that there are many companies poised to benefit from strong secular growth trends, such as the strengthening emerging markets consumer, the rise of autonomous and electric vehicles and the growth of robotics. We wanted to take our clients to Japan to explore the idea that it may be the world’s most underrated equity market and therefore provide tremendous wealth creation potential.
What were clients seeking to learn from the Tour and what were the major takeaways?
KK: Our clients on the Tour, who represent $3.2 trillion in assets, wanted to gain a deeper, first-hand understanding of the changes happening across Japan – from economic policy to corporate culture to shifting social attitudes. We met with executives at leading companies including Softbank, Takeda, Shiseido, Nidec and others.
From our conversations with these companies, it is clear that change – even if slow – is happening everywhere. For one, we’re seeing companies once again focus on investing in innovation. As Takeda’s CEO, Christophe Weber, highlighted: Japan has a long history of innovation, having been at the forefront of many major advancements in the 1970s and 1980s. And, even in recent years, Japan has remained a leader in many areas of R&D, but has suffered from an inability to successfully commercialize such work. Takeda’s decision to partner with Kyoto University’s Shinya Yamanaka – who won the 2012 Nobel Prize for his work in stem cells – is just one example where the private sector is helping to change this dynamic.
Many Japanese companies are also extremely well placed to benefit from the Fourth Industrial Revolution and the pervasive nature of technology. Micro motor and electronic component manufacturers, such as Nidec and Murata Manufacturing, are now critical suppliers to companies across industries like electric and autonomous vehicles, robotics and automation, the Internet of Things and 5G. So, while they may not be the first companies investors would think of when they consider these secular themes, they are among the best placed to benefit globally.
What are some of the macroeconomic headwinds Japan is facing?
KK: Japan has the highest level of debt-to-GDP ratio of any developed country. The country is struggling to generate inflation and its aging population is estimated to fall to 100 million by 2050 from 127 million today. But there are positive changes on the horizon. Women are entering the workforce in greater numbers – a topic on which my colleague, Kathy Matsui of Goldman Sachs Research, has written extensively about in her “Womenomics” research. And while immigration is still a politically sensitive issue, the government is issuing more temporary three-year visas and student visas, signaling an increasing openness.
You have visited Japan for many years. What are some of the biggest changes that you’ve seen?
KK: We’re seeing a big shift in how companies are talking about corporate governance. When I first went to Japan, management teams were often very evasive when you challenged them on corporate governance initiatives. At best you would get vague or unsatisfactory responses, at worst they would walk out of the meeting! On our latest Investor Tour, nearly every speaker addressed corporate governance reforms proactively and shared their efforts to improve diversity and shareholder returns. For example, Jun Ohta, president and group CEO of Sumitomo Mitsui Financial Group, highlighted the fact that 99% of companies now have at least two independent directors on their board, compared with only about 20% in 2012. Proxy voting procedures are more transparent while the practice of cross-shareholding – or mutual holdings among allied companies – is down, especially at financial institutions.
We also observed a new willingness from companies to look outside their organization for talent and fresh ideas – an approach that has been historically uncommon. For example, Masahiko Uotani, Shiseido’s CEO who previously worked for Coca-Cola, and Christophe Weber, Takeda’s first non-Japanese president and CEO, have both broken down silos across operating businesses, driven greater innovation, enhanced the global orientation and increased diversity of the management team and the board of their respective companies. As these changes continue to emerge across the Japanese corporate landscape, our confidence that they can be self-sustaining also increases.
How are foreign investors typically exposed to Japanese equities in their portfolios?
KK: Most foreign investors get exposure to Japanese equities through an EAFE or a global allocation, with most global mandates ending up with roughly a 10-15% allocation. From our perspective, we believe a strategic, standalone allocation can be a superior approach. Overall, the pace of change across Japan Inc. is uneven and we expect to see a wide range of outcomes for Japanese corporates. Those that are aligned to key secular growth trends and are fully committed to improving governance and enhancing minority shareholder returns should be exciting opportunities. Those that fail to adapt, or are unwilling to change, should suffer. This backdrop for there to be new winners and losers, ultimately makes Japan a compelling market for stock pickers.