Japanese equities: Overlooked and underloved

After a positive 2020, Japanese equities have underperformed most other developed markets over the last 12 months, not helped by stringent Covid restrictions, supply chain disruption and rising commodity prices. GAM Investments’ Reiko Mito explains four reasons why, despite these headwinds, she believes there is reason for optimism.

04 May 2022

Record levels of share buybacks

In the last 12 months (as at 31 March 2022), Japanese companies have announced a record JPY 8.1 trillion (USD 64 billion) of share buybacks, an increase of 68% on the previous 12 months. This is testament to the confidence management teams have in Japanese companies’ underlying fundamentals. While dividends are valuable to investors, share buybacks represent a meaningful way of compensating shareholders – regardless of the timing of the holding – while also benefiting the companies themselves.

Corporate governance improvements

Japanese companies have been striving to improve their corporate governance in recent years. Revisions made to the Japanese Corporate Governance Code, which became effective in June 2021, are particularly worthy of note.

First, companies listed on the Prime Market (the top-tier classification of the Tokyo Stock Exchange) are now required to enhance the quality and quantity of disclosure based on the Task Force on Climate-Related Financial Disclosures (TCFD). While many companies are considering what data to collect and how to disclose, this marks the beginning of a considerable phase of improvement in our view.

Second, the Code stipulates companies should pay greater attention to improving diversity. In part due to Abenomics, women’s participation in the labour force has increased in recent years, but there is still much to do. Many companies, particularly in the machinery sector, argue that there is a lack of women who have both a technical and managerial skillset. Statistics from the OECD indeed show that the female share of graduates in the fields of science, technology, engineering and mathematics in Japan is among the lowest at 15%, compared to 36% in the US and 39% in the UK¹. Companies have made low level efforts to date, such as organising periodic female training programmes or sending female alumni to present at universities, but during the AGM season in May we expect to see companies showcasing more tangible improvements.

Low inflation environment

Inflation has been most striking in the US, where it eclipsed 8.5% in March. In contrast, inflation in Japan is likely to hit 2% in the coming months. While Japan cannot be immune to some acute inflationary pressure given it imports most of its raw materials, including food and energy, commercial practice in the consumer space is to maintain prices. When input prices increase, consumer goods manufacturers tend to reduce the contained amount instead of raising the surface price.

There is some risk that the era of low rates and predictably low inflation may come to an end, particularly if the Japanese government decides to deregulate the strict labour laws, but this is not our base scenario at present.

Global leader in robot manufacturing

Japan is the world’s number one industrial robot manufacturer, delivering 45% of global supply. In recent years, the country’s robot suppliers have increased their production capacity considerably, with their export ratio rising to 78% in 2020, when 136,069 industrial robots were shipped.²

According to our recent research, robot manufacturers have become increasingly confident in introducing digital twin which, simply put, is a virtual copy of physical machines. Digital twin uses software (or more specifically a CNC simulator and robot simulator) to simulate the individual robots, processes, systems and people in production lines. Given programming and integration account for approximately 50-70% of the cost of a robot application and have historically made robotic automation too costly for many manufacturers, we regard this new technology as a differentiator.

Indeed, several robotics manufacturers have recently told us that their client base has diversified significantly from conventional automotives to new industries with short production runs of a wide range of products such as batteries, food and pharmaceuticals and we expect this to continue.

Clearly then, despite the challenges Japan has recently faced, we believe there are a number of reasons to be positive about the prospects of Japanese companies going forward. With that said, we believe active management remains key in selecting those firms which may deliver strong returns over the long term.