Yet again, Japan has been left behind. The US has returned nearly 20% this year and Europe 16%. Japan has returned 7%. There are two possible explanations: the “secular stagnation” of Japan and the lack of interest from professional equity investors.
Economic growth of below 1% limits the potential for domestic companies, although there are plenty of opportunities overseas. There is nothing novel about Japan’s slow growth. It is the result of a falling population; output per capita is as robust as anywhere in the developed world.
Japan: a 20% discount to America
Inflation is also below 1% and government bond yields are negative, which makes Japan’s high level of sovereign debt affordable. Lax monetary policy is accompanied by what Udith Sikand of Gavekal Research describes as an “extraordinarily tight” fiscal stance.
Analysis by Thompson Reuters at the end of March estimated the Japanese market to be trading on 13.5 times 2019 earnings, slightly higher than Europe, the UK and emerging markets, but 20% less than the US. It also anticipated a 2.7% drop in corporate earnings this year and growth of only 3.7% next, though both figures look too pessimistic. Of course, market averages can hide a multitude of traps and opportunities. Simon Edelsten, co-manager of Mid Wynd International Investment Trust, enthuses about NTT, Japan’s telecom giant. Revenues haven’t grown for 25 years, but earnings per share have doubled in five years, thanks to efficiency improvements and share buybacks. The shares still only trade at the book value of the assets. Joe Bauernfreund, manager of AVI Global Trust (AGT, formerly British Empire) is focusing on the outstanding value in smaller firms. Japan now accounts for 21% of AGT’s portfolio and £100m has been raised for a new trust, AVI Japan Opportunity Trust (LSE: AJOT), to invest alongside. “People say that nothing ever changes in Japan,” he says, “as a result of which there are overlooked, neglected and mispriced assets.”
Japanese firms have piles of cash
Japanese smaller firms, he says, trade, on average, at only 7.9 times cash flow, barely half the European figure. Yet they have returned an average of 11% per annum over ten years and 14% over five. What’s more, 900 firms have more than 40% of their market value in cash. His portfolio of 30 companies has 83% of its market value in cash and listed securities, leaving the businesses valued at less than three times cash flow, despite a return on equity of 20%.
The median market capitalisation is £400m, so these are not tiddlers, yet 90% of them are covered by two or fewer analysts, so they go unnoticed. Why invest now? “The combination of extraordinary undervaluation, corporate governance reform… and growing shareholder activism.” Historically, accountability to shareholders was poor and companies protected each other through cross-holdings. Only 5% of companies have a majority of independent directors. Poor share-price performance was the result.
The key to change, Bauernfreund says, is sympathetic rather than aggressive engagement with companies. The strategy is already working with a two year return of 15.8% in AGT from Japan against a Topix index return of 2.1%, while AJOT has returned 5.1% in seven months when the Topix index is down 1.3%.
The other explanation for Japan’s lacklustre recent performance is that many investors regard the country, with its impossible script and idiosyncratic customs, as too troublesome and expensive to bother with. Until, that is, renewed outperformance makes fools of them. Bauernfreund’s enthusiasm suggests that may be in sight