Implications for Japan Around Prime Minister Abe’s Resignation
As of November 2020
An International Roundtable Conversation…
Harbor has the benefit of sharing thoughts and perspectives with a diverse set of asset management partners around the globe – up and down the cap spectrum, across different styles or geographies – we can go anywhere, providing the Harbor Lens.
In September, Shinzo Abe resigned as Prime Minister (PM) of Japan and was replaced by Yoshidide Suga. Abe was Japan’s longest serving PM, having served from 2006-2007 and then again from 2012 until his resignation. A critical initiative of his government was an attempt to lift Japan out of a longstanding deflationary cycle and attract more foreign investors to Japanese stocks through a set of economic and corporate reforms that became known as Abenomics, which consisted of the so-called “3 Arrows” of easy monetary policies, fiscal stimulus, and corporate governance reforms.
We assembled a group of Japan experts from Harbor’s subadvisers to discuss the significance of this change on Japanese markets and what will become of Abenomics.
Sonya Morris (SM): How would you describe Abe’s legacy on corporate Japan and on Japanese stock markets?
Alex Narboni (AN): While flying under the radar of his higher-profile policies around quantitative easing and currency stabilization, Mr. Abe also achieved deregulatory changes that were positive for Japanese stocks. He opened Japan’s labor market to women and to foreigners by allowing more flexible employment rules. His legacy will also be on the diplomatic front, as Japan maintained a working relationship with both China and the U.S., despite the ongoing friction between those countries. Under Abe’s leadership, we witnessed positive change in the governance of Japanese companies, helping improve the perception of Japan from both domestic and foreign investors. More than anything, Mr. Abe said that Japan could grow again, and the unquantifiable psychological impact of that was profound. The changes and positive undercurrents he promoted should be lasting, enhancing his legacy.
Iain Campbell (IC): There is no doubt in my mind that Abe’s legacy on corporate Japan is a positive one. Corporate governance has taken several steps forward under the Abe administration and while there is still plenty of room for improvement, he has left corporate Japan with much higher standards of governance, improved shareholder communication practices and more diverse board membership than when he took power in 2012. Less talked about, but equally important is the stable environment he shaped domestically (after a revolving door of PMs in the years before his arrival) and internationally, particularly in relations with China. This has been beneficial to the large base of Japanese exporting companies and (recent travel restrictions aside) the booming Japanese tourist industry.
SM: How has Abenomics effected the opportunity set in Japan? Has it influenced where you look for ideas or made some industries more attractive than others?
AN: We have been meaningfully exposed to Japan for years. Having a research office in Tokyo has enabled Japan to be a strong source of idea generation for us. Through our bottom-up, quality growth approach, we search for companies capable of compounding their earnings over the long-term and, given the under-researched and often misunderstood nature of the Japanese market, we have found a number of companies that fit our criteria trading at attractive valuations. These ideas are sourced from across industries and sectors, but many have come from the industrial and consumer verticals.
Many of our Japan investments are positioned to capitalize on ‘Changing Japan’ trends, as beneficiaries of deregulation or of the better efficiency promoted by Abenomics, as needed given the demographics in Japan. One example, Hikari Tsushin, a provider of workflow solutions to small companies, benefited when new regulations enacted in 2016 opened electricity distribution to broader competition.
Pan Pacific International Holdings (previously known as “Don Quijote”) is another prime example. They are one of the few retailers in Japan growing their store base, as most of their competitors are shrinking. This discount retailer, selling everything from sundries to electronics to jewels, has benefited from easier regulations on store openings and easier access requirements for tourists, including the Chinese. Under Abe’s leadership the number of tourists in Japan increased from 8 million a year to 30 million a year. This greater openness to tourism has enabled Japanese corporates to serve as a conduit for investing in the dynamic trends across Asia, and China in particular.
As quality growth investors, an emphasis on governance and engagement has always been a priority for Comgest, but the heightened focus spurred by Mr. Abe has helped draw incremental investor attention to the Japanese stock market.
IC: Our investment approach is one of bottom up stock-picking; we tend to construct our portfolio as a collection of individually attractive companies rather than expressing a view on industries. That said, we have found a growing number of attractive disruptive companies in Japan and the policies of Abe, with their focus on improved efficiency, have been a helpful tailwind for such companies. We have also had long-term holdings in businesses which are undergoing a period of restructuring and improvement such as Shiseido and Olympus, and I think that the pro-corporate governance policies of the Abe administration have been supportive for this process.
Bill Arah (BA): Longer term, if signals shift in stasis and move to more fiscal rather than monetary policy then it should be good for value versus growth, domestic versus export, TOPIX versus Nikkei: here’s hoping. Corporate change in Japan wasn’t and isn’t politically driven; the Japanese government may be the largest promoter of this change (‘activist’ within Japan, if you will), but it emanates from within those companies themselves and is a function of changing mindsets within Japan (particularly as the labour force demographics evolve). Suga (and his appointees) may actually be more pro-reform than Abe, but in both cases, they are reflecting, again, social/demographic shifts that we believe are structural.
SM: Do you think corporate governance reforms will continue under PM Yoshidide Suga? Or might they evolve in a different way? And how do your views on this matter impact your assessment of the opportunity set?
AN: Like Apple after Steve Jobs, we expect Japan under Mr. Suga to continue its current path. These changes are reflective of a deeper evolution of Japanese society and are bigger than any one person. In fact, Mr. Suga was the architect or catalyst for many of these initiatives while serving as Mr. Abe’s Chief of Staff. His early focus on regional bank rationalization, the digital economy and, by extension, the ongoing reform of old industries and competition may only be a foretaste. Our views on the opportunity set in Japan remain intact, but we continue to be focused at the company-level.
IC: We expect many of the reforms and policies to continue under PM Suga. Suga was chief cabinet secretary under Abe and therefore already an influential figure before he became PM. We know that he has interest in cutting unnecessary bureaucracy, and he may push harder on the existing policy programs in this area. We are interested both in companies that have the potential to see savings from efficiency improvements and in companies that may facilitate such improvements, for example by digitizing business processes.
BA: Governance change is the critical shift; it is being supported and encouraged by the government and bureaucracy, as for instance the Ministry of Economy Trade and Industry (METI) paper on corporate restructuring; ultimately Japan needs to unlock/create wealth to fund future liabilities.
Governance shifts are underpinned by the breaking of the post-War lifetime employment system. Covid is acting as a major factor here, pushing a move to job-specific hiring and the ability to be paid according to results/output. Young Japan wants this.
SM: How do you see monetary and fiscal policy evolving under the new PM and how might that impact stocks and the overall economy in Japan?
AN: Mr. Suga has not made changes to the Finance Minister, the Foreign Affairs Minister or the central bank Governor, which demonstrates his intention to keep the economic growth focus intact. Japanese corporate profits have grown at a strong clip since Abe took office in 2012 and it is comforting to see the direction of economic and monetary policies are being maintained.
IC: We would expect monetary and fiscal policy to be similar under the new PM. The Governor of the Central Bank Haruhiko Kuroda’s term does not expire until 2023 and we expect his accommodative monetary policies to continue. That said, we do not tend to pick stocks based on whether they might be beneficiaries of monetary or fiscal policy. We have more conviction investing in companies where, because of some technological or cultural reasons, we think have the potential to be long term winners. That said, we prefer companies which are “masters of their own destiny” rather than simply beneficiaries of government policy.
BA: With interest rates pegged at zero, inflation likely to show up in the years ahead, and COVID-19 and the economy likely to get better from here, we believe stocks are the only game in town. Historically, you want to buy during times of fear and volatility, not when the stock market is up, and no one is fearful. For context, there is $4.2T in cash on the sidelines right now, suggesting there is plenty of fear in the market.
SM: Are there any knock-on effects from the results of the U.S. election that could impact the opportunity set in Japan? For example, could the U.S. election impact trade relations so that the Japanese companies and the Japanese economy are affected?
AN: Mr. Abe called Mr. Obama ‘Barack’ in public and the two men hugged at Hiroshima. The Japanese seldom hug and almost never in public. The day after Donald Trump was elected, one world leader showed up at Trump Tower, and it was Mr. Abe. Japan is a very pragmatic diplomatic player and has been engaging with U.S. protectionism since the 1970s. We are hopeful this mindset will continue under the leadership of Mr. Suga.
IC: There could well be knock-on effects from the results of the U.S. election and even if trade tensions are not directed at Japan, there are Japanese companies that through their international operations may be affected. We see this as an area of significant uncertainty. However, second guessing the election result and what impact it will have on the Japanese economy is not an area where we think we can add any value. Our approach is to invest in high quality resilient businesses run by talented management teams on the basis that such businesses are best placed to prosper in the long term, regardless of shorter-term disruption.
SM: In spite of Abe’s significant focus on economic reforms, he really couldn’t make much progress in lifting Japan out of the deflationary cycle that the economy has struggled with for many years. How has decades of deflation influenced the behavior and capital allocation decisions of corporate executives in Japan? And how has it impacted investors’ views toward Japanese stocks?
AN: Japan’s corporate profit growth has been strong, inflation ex-fuel has turned positive, the stock market has doubled during Abe’s office, and Warren Buffett’s arrival potentially symbolizes Japan has become a focus of long-term investors for the first time since the 1980s. The capital allocation approach of Japanese companies is becoming more shareholder friendly. While they have historically kept cash-loaded balance sheets, today they are more active with their share buybacks and pay-out ratios. One example of this shift is Shin-Etsu, a leading Japanese chemical group we have been invested in for over two years. The company consistently held a cash balance of close to 20% of their market cap, enabling them to invest in times of crises as their competitors struggled financially and when assets were on the cheap. In recent years, Shin-Etsu has raised its dividend and introduced an attractive share buyback program. However, while there are examples of changing capital allocations, it is worth noting that many of the desired traits investors have focused on during the Covid-pandemic, have long been existent in Japanese companies.
The paradox around the fundamental attributes of Japanese corporates is rather fascinating. Many of the questions being asked of companies on the back of this pandemic (i.e. will you keep your employees, is it your responsibility to consider all stakeholders, will you pause share buybacks, etc.) have been lasting components of Japanese corporate cultures. Much of the low hanging fruit from which investors questioned investments in Japan – holding large amounts of cash, a reluctance to lay off workers, placing stakeholders ahead of shareholders – are not only helping Japan prove more resilient, but are also becoming sought after attributes by investors. While the notion of benefitting all stakeholders is a growing element globally, whether linked to environment, social, and governance (ESG) or not, Japan’s approach to capitalism remains fundamentally unchanged. The importance of these elements was on center stage as analysts stress-tested their models at the start of the Covid-pandemic. In some ways Japanese corporates were the original ESG companies, which is why they have long been a fit within our quality growth framework, and why they are increasingly garnering investor attention.
IC: I think it is difficult to speak in general terms about the impact of deflation on the capital allocation of corporate executives in Japan. While some would argue that it has led to bloated, cash-heavy balance sheets and excessive conservatism in capital expenditure I think this is an over-simplification and does not apply to all Japanese corporates. Through on the ground research and bottom-up company analysis we have been able to find plenty of dynamic, outward looking Japanese companies which compete effectively on the world stage and have decades of growth ahead of them.
BA: Deflation has totally subdued Japan’s animal spirits and led to extreme risk aversion in asset allocation; this investment implication has swamped corporate Japan’s actual performance which has been quite good (as good as U.S. or Europe). If governance in Japan shifts it will validate equity investing and drive return improvement in the value.
The key issues for next cycle (the post Covid-19, post Global Financial Crisis cycle) are hence governance and inflationary expectations. We think both will probably be different, maybe ending the key trends of last 35 years, Japan is the only market where governance may move in your favour as a shareholder and it is the play (due to asset allocation and debt) on inflation.
SM: I appreciate the discussion and perspectives on this relevant topic. In conclusion, while there will be some changes given the change in leadership, the panel remains favorable on the positive changes already underway in Japan and sees continued bottom-up opportunities. As always, we believe an active, long-term disciplined approach, to investing in non-U.S. equities, including Japanese stocks, has potential for success.
Activating International Equities
At Harbor, we believe international equities hold important benefits for U.S. investors. There are many reasons to increase strategic allocations to non-U.S. stocks:
- International stocks may not add risk to a diversified portfolio, and they provide an important source of income and diversification.
- Go active: International markets have proven to be a fertile area for active managers, and we believe they will continue to provide opportunities in the future.
- Given current valuation levels, relative to U.S. equities, now may be an attractive entry point.
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The views expressed herein are those of Harbor Capital Advisors, Inc., Comgest Asset Management International Limited, Baillie Gifford Overseas Limited, and Marathon Asset Management LLP investment professionals at the time the comments were made. They may not be reflective of their current opinions, are subject to change without prior notice, and should not be considered investment advice.
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