After nearly 30 years in the doldrums the Japanese market is rising again, attracting increasing investor interest and press headlines. The Nikkei is at a 21 year high, the TOPIX index is at a 10 year high and the LDP just won a thumping majority in parliament. But there have been many market rallies since the bubble burst in late 1989 and typically they were false dawns, followed by lower lows in the market. Could this time be different?
One of the three Kames Global Equity Income portfolio managers – alongside lead manager Mark Peden and Douglas Scott – Robin Black, is a long time follower of the Japanese market.
“Japan has too many structural challenges to be a long term buy and hold market. The aging population, large budget deficit, high debt to GDP, reliance on imported energy, lack of political diversity, inefficient work practices and some corporate attitudes not well aligned with shareholders are all significant headwinds, albeit ones well known to most market observers. That said, Japan remains the third largest equity market and the third largest economy in the world so when the market’s performing well it’s a dangerous market to be underweight.”
Despite not being a structural long term bull, Black observes Japan can outperform for long periods at a time: “Japan typically performs well when global economic conditions are improving and that’s most certainly the case just now as evidence of global synchronised growth is mounting. For instance, the IMF see global economic growth of 3.5% in 2017 and 3.6% in 2018, up from 3.2% in 2016. Japan performs well in such periods because it’s such an export based economy and a weak Yen compounds the benefit. Add to that the fact the market is relatively cheap on 1.4x book and the cost of capital remains close to zero, thanks a to very accommodative monetary policy from the Bank of Japan. Altogether these conditions are very favourable.
“The fund has been overweight Japan for the past year and this is a position we believe is likely to persist as a result of our bottom-up stock convictions. We have nearly 10% of the fund in Japan, which compares to a benchmark weighting less than 8% and our competitors, who typically have less than 5% in Japan. The market has done very well for the investors in our high active share fund.”
Below, Black highlights four Japanese companies held within the Kames Global Equity Income Fund which “illustrate the depth and breadth of the market”:
“Tokyo Electron is a global leader in manufacturing the machines the semiconductor companies use to make chips with. We bought the stock last year realising that the increasing number of applications for semiconductors, coupled with rapidly increasing amounts of data being stored, would mean supply could not possibly keep up with demand. The share price has doubled in the past year and rapid earnings growth, coupled with a 50% pay-out target, means that the dividend has grown from 50 Yen in 2014, to 352 Yen last year and they forecast 605 Yen this year.
“Bridgestone is the world’s leading tyre manufacturer. The simple passenger vehicle tyres are becoming more commoditised, but Bridgestone and Michelin enjoy an effective duopoly in the larger, more profitable, tyres such as those used on mining or agricultural equipment. Bridgestone has net cash on the balance sheet and is very cash generative so it could afford pay a higher pay-out ratio than last year’s 40%. In some ways this bloated balance sheet is frustrating as it suppresses the ROE, but we appreciate the conservative management, and the low pay-out ratio may improve in the future.
“Daito Trust has been in the fund since it was launched. They construct condo’s for the rental market. We like the integrated model they operate as they find the land, construct the rental building, attract the tenants and manage the property. Recent changes in the inheritance laws have made owning rental properties very tax efficient, this was an unexpected boost for demand. Daito aim to return 80% of their profits to shareholders, last year that was 50% through a dividend and 30% through a stock buyback.
“TechnoPro is a technology focused staffing and services company, so are very much exposed to domestic trends such as economic growth, the unemployment rate and wage growth. They have over 14,000 engineers and they work with 1400 companies. The staffing industry in Japan is very fragmented and legislative changes mean consolidation is likely – a process TechnoPro will benefit from. The pay-out ratio is 50% but an improving balance sheet and decent free cash flow generation offers scope for this to increase in the future.
“The stocks we own in Japan represent several of the qualities we look for in companies; good balance sheets, strong cash flow, dominant market positions and solid management supportive of shareholder returns. All of which underpin our philosophy to equity income investing, the compounding of stable returns over time.”
The Kames Global Equity Income Fund has returned GBP 53.3% over the last three years, a performance which places the fund in the top decile of its 93 fund peers while retaining its Lipper Leader status for Preservation*.