One question has gripped investors since the appointment of Kazuo Ueda as the new governor of the Bank of Japan: when will he abandon the ultra-loose monetary policy of his predecessor Haruhiko Kuroda?
Doubtless, this is an important consideration for investors in Japan.
But it is far from the only major development in Japan to which investors should pay close attention, particularly those with a leaning towards value.
At the end of March, Japan Exchange Group (JPX), the operator of the Tokyo Stock Exchange (TSE), outlined the new JPX Prime 150 Index.
It will be made up of 150 stocks selected to represent "Japanese companies that are estimated to create value".
It will comprise the top 75 names in the TSE Prime Market by market capitalisation whose price-to-book ratio is greater than 1.0 times, and the top 75 names in terms of estimated equity spread (the difference between return on equity and cost of equity).
Clearly, Japan has been a market in which companies have not sought to maximise shareholder value.The creation of the index is significant for a number of reasons.
Most notably, it gives teeth to the TSE’s recent decision to demand capital improvement plans from companies languishing on sub-par valuations (partly a naming and shaming exercise).
If being outed as a laggard was not enough, the prospect of failing to make it into this exclusive index will provide a powerful incentive to management teams to improve their profitability and corporate value.
It is notable that some significant names will be under scrutiny – even Honda would not make it into the index on its current valuation.
All told, these corporate reforms, as well as the others that accompany them – including those seeking to tackle traditional Japanese market bugbears like cross-shareholdings – represent the most important transformation in Japanese governance the investment team has ever witnessed.
Assessing the impact
For investors like us, the drive towards better corporate governance provides additional leverage in terms of our influence over the companies in which we invest.
It is fast becoming untenable for management teams to brush off investor efforts to force companies to act in a more shareholder friendly manner.
Failure to directly address a low stock price is, as the government and the stock exchange implement major corporate governance reforms, not going to be a sustainable investor relations strategy.
There is nowhere else in the world where investors will find such a ‘self-help’ approach to improving returns.At the same time, this will make management teams in Japan, who historically have played a backseat role compared their global peers, more important.
Management meetings in Japan are often focused on long-term, top-down issues, with little or no attention to key financial metrics.
Now executives are by and large far more willing to discuss their plans to improve shareholder returns.
Not all will do so substantially or in a uniform way. Progress will inevitably vary according to each company’s ability and inclination to change. But we are getting a much clearer sense of the quality of management teams due to these reforms, and that will help us pick the winners.
A significant opportunity
The numbers highlight the size of the opportunity. The companies in the TSE’s crosshairs – those trading at a P/B of below 1.0 times – account for 50 per cent of the TSE Prime Index (and 65 per cent of the Russell Nomura Total Value Index). Compare this to the S&P 500, where just 3 per cent of names trade at such low valuations.
Clearly, Japan has been a market in which companies have not sought to maximise shareholder value.
Today, however, there is nowhere else in the world where investors will find such a ‘self-help’ approach to improving returns.
As well as longer-term efforts to improve profitability, investors can now expect to see companies reducing cash and increasing share buybacks, as well as other improvements to capital policy, as these represent low-hanging fruit for companies that have historically shunned such practices.
The corporate governance movement is already here and picking up steam.So where do the biggest opportunities lie?
Companies trading on lower valuations tend to be old economy assets and as value investors we currently favour unloved domestic-facing stocks.
Retail, chemicals, transport and logistics, construction and real estate companies fall into this category, while energy stocks also present an opportunity.
Select technology companies – those lacking the high valuations of their global and US peers – are also attractive.
More broadly, with policy normalisation on the horizon, life insurers look well placed to flourish. Given the recent fallout from the collapse of SVB the upside for banks looks somewhat capped.
Life insurers, in contrast, offer no risk of deposit flight (customers cannot ask for their premiums back) and represent an attractive way to benefit from potentially rising rates without the danger of a liquidity event.
We will know more about the BoJ’s direction of travel in the coming weeks and months.
But the corporate governance movement is already here and picking up steam.
As Warren Buffet’s recent decision to increase his weighting in Japanese equities shows, it is rapidly becoming an exciting time to be a value investor in Japan.
Jeff Atherton is lead manager of the Man GLG Japan CoreAlpha Fund
