Japanese prime minister Shinzo Abe’s Liberal Democratic Party (LDP) recently lost over half of its seats in the Tokyo assembly, calling into question the popularity of Abenomics and raising the prospect of further political upheaval following 2018’s general election.
Should investors be concerned? Mr Abe is Japan’s third-longest serving prime minister since the second world war, and while the Tokyo elections were clearly a setback, Japanese politics remains remarkably stable, especially when compared with the rest of the developed world. Mr Abe’s approval ratings have fallen following allegations of cronyism and his pursuit of constitutional reforms, yet the opposition Democratic Party are hugely unpopular and seemingly pose little threat to the status quo.
The setback might also lessen Mr Abe’s focus on national security reforms and increase the emphasis on his economic agenda. While Abenomics has had its failings, the ambition to promote economic revival retains strong public support. Irrespective of what happens in the election, Mr Abe’s reforms have already had a positive impact on corporate Japan. In particular, the introduction of governance and stewardship codes has facilitated the unwinding of cross-shareholdings, spurred growth in the number of independent directors on company boards, and led to a greater focus by management on improving shareholder returns.
In other respects, progress remains slow. One common criticism is that the majority of domestic institutions are passive investors, voting in favour of management regardless of how they act. A recent update to the stewardship code seeks to address this by placing pressure on institutions to disclose and explain how they have voted at AGMs. By doing so it is hoped that Japan’s large institutional investors will make management teams more accountable for their actions.
The country is heading in the right direction. With many US companies generating historically high profit margins and trading on weighty valuations, there is some solace in the fact that corporate profit margins in Japan have significant room for improvement.
There is also greater value to be found in Japanese equity markets. We favour Morant Wright, an asset management boutique focused solely on the country. Established in 1999, Morant Wright’s six experienced fund managers invest with a significant margin of safety in firms that have robust balance sheets and stable franchises. Their investment approach has led to strong outperformance over the long term, but it has been out of favour more recently.
In Japan, as elsewhere, there has been a significant divergence in the performance of so-called value and quality stocks, with the former lagging and the latter rising strongly. However, as valuations have increased across developed markets, the team’s disciplined application of its investment process has ensured the Morant Wright portfolios remain attractively valued. For instance, its Sakura fund trades on a price-to-book ratio of around 0.9 times as of the middle of this year, a significant discount to the wider Japanese market.
The companies in the portfolio also typically have net cash on their balance sheets, and are consequently well placed should corporate Japan continue to focus on improving shareholder returns.
Tom Yeowart is the manager of Troy Asset Management’s Spectrum funds
