Magazine issues » July 2021

Roundtable: How well geared are Japanese assets for a new world?

As we prepare to emerge from Covid, experts look at overcoming demographic issues through a combination of good tech and corporate governance, improving productivity and meeting an ambitious government carbon emissions reduction target. Chaired by Romil Patel. Japan_roundtable_July_2021 Kensuke Niihara (Chief investment officer – Japan, State Street Global Advisors)
John Vail (Chief global strategist, Nikko Asset Management)
Archibald Ciganer (Portfolio manager – Japan equities, T. Rowe Price)
John Paul Temperley (Portfolio manager – Japan equities, Axa Investment Managers) Funds Global – Which themes and sectors in Japan are you constructive on and what do you see as the top three investment risks amid a difficult first quarter? John Vail, Nikko Asset Management – The top risks are the global macro environment, the virus and its variants, especially as such is connected with the success of the Olympics – if any of those situations go badly, it wouldn’t be helpful in the short run. In the medium term, I’m not one who thinks that demographics is a problem for Japanese corporate profits. In fact, we’ve had poor demographics for quite some time, but corporate profits have increased strongly. Any country can overcome a demographic problem with good technology if they’re good at corporate governance – and Japan’s corporate governance has improved like night versus day in the last ten years, though it still has further room to improve. On the global macro front, US-China relations are key, and Japan’s shift from the middle towards the US side, especially in linking with Taiwan more closely. The cabinet here is very dedicated to Taiwan and so China has some issue with that. China needs Japan quite desperately on the technology side and in many ways, China does not want to become an enemy with Japan, even though it’s poking its finger at it with constant minor military incursions. Essentially, China is trying to maintain a decent relationship with Japan. Kensuke Niihara, SSGA – Japan is currently experiencing increasing infection rates, our vaccination rollout has been slow, but there could be a potential upside in the long run – towards the end of the pandemic, there will be a cycle of recovery. From a risk perspective, if it turns out that there are issues with the vaccinations that we are currently unaware of and if it impacts the US recovery situation, it could present a risk globally. On the macro side regarding rates and inflation, it’s not a Japan thing but it could impact the global macro economy and the global liquidity cycle, which could eventually impact the Japanese market, as Japan has tended to react to all other markets in the past. We are not as concerned as some other investors on the rise of inflation. We think it’s a fair level considering the long-term market or economic conditions. On the political side, again, under the previous Abe administration, Japan’s market and political conditions tended to be seen as relatively stable compared to the US and Europe, but seemingly it’s the opposite now. The US and Europe have a more solid cabinet or government conditions and political support, and Japan is the opposite. I don’t view this as the main scenario, but in the coming two to three years, we need to think about the market and the next stage of the Bank of Japan’s (BOJ) policy. Again, I don’t expect a big change even after the election, but a change of government or administration could lead to the BOJ policy changing to some extent. This could be a risk in the long term. John Paul Temperley, Axa IM – I agree in the sense that Covid-19, inflation and so on are macro risks around the world right now, but to be honest, the way we see them at Axa is that those macro risks are out of our control. From an investment portfolio risk perspective, we would see the biggest one as not taking profits in stocks that did particularly well from the Covid-19 situation last year, and that’s something that’s been vexing us, certainly in the first quarter. So, stocks like Daifuku, which is a global leader in material handling equipment in warehousing. Obviously that’s benefited hugely from the Amazon boom once the lockdowns hit globally, and the share price did fantastically well, but it was trading on north of 50 times PER [price-to-earnings ratio] for not that much growth as we could see it. In short, taking profits in stocks that benefited from abnormal demand last year, and it was very important not to lose sight of our investment process. That would be the key risk in terms of managing the portfolio risk in the current environment. Niihara – In that sense, from an investment and product pitching perspective we favour quality companies, but we are moving away from pure growth. We like sustainable growth in the long run with reasonable valuations. We consider quality based on market position, financial conditions, transparency and fundamental momentum. It’s quality-related factors that we favour when communicating with clients and investors. Archibald Ciganer, T. Rowe Price – There is an interesting debate here between what John Paul said and what Kensuke said. One very powerful trend in Japan is any service that would help raise corporate productivity in the country. If you read the press, it’s all about digital transformation, which sounds like a very fashionable theme, but there’s something behind it, which is that productivity in Japan is very low and it needs to be improved. It’s an interesting juncture because a lot of the companies that provide these services – I’m talking about software as a service (SaaS) companies and software in general – did fantastically well during the pandemic because of the lockdowns, with everyone moving to working from home, and their valuation expanded tremendously. On the one hand, you want to take profits, as John Paul said, because some of these are really stretched. But on the other hand, you don’t want to miss the forest for the trees, because a lot of these companies will see accelerated adoption of their technology because of the pandemic and with many corporates realising that they have to be ready for the next emergency, and so if you are too aggressive in taking profits, maybe you minimise your losses in the short term, but you also miss the real upside that’s yet to come in many cases. I don’t want to generalise because every company is different, trading at different levels, etc, but that’s the key debate this year: what is reasonable in terms of valuation, what exposure do you maintain to these long-term secular growers, and how do you manage the short-term valuation compression? Funds Global – How is Japan benefiting from the global tech cycle and where are you identifying new investment opportunities and attractive long-term sustainable returns in terms of companies that can adapt to this shift – particularly in a post-Covid world? Ciganer – In the US, tech means hardware and software, but mostly software, and in Japan, tech means hardware, so it’s very confusing. Here in Tokyo, Facebook is not a tech company, but in the US, it’s a tech company.
Clearly Japanese component manufacturers, tech hardware manufacturers and automation technology companies are still critical, and they are still, for the most part, very competitive. The interesting development is that you are seeing a duplication of the global tech supply chain as the US and China untangle their relationship, at least for critical technologies, and Japanese companies are well positioned to benefit from this duplication of demand. Effectively, for those companies that can navigate the political situation, the addressable market is potentially doubling, so that’s very interesting for Japanese companies. At the same time, Chinese competition is catching up at a tremendous pace. Just a few years ago, Japanese companies were still very dismissive, saying that it would take 20-30 years for Chinese competitors to catch up, and lo and behold, five years later some of the Japanese companies are already threatened, and it’s going to be a lot tougher for Japanese companies to survive. As fundamental investors and stock-pickers, a big part of our role when investing in tech is to identify those companies that will be able to maintain their competitive advantage and those that are about to see a strong rival emerge or their products become commoditised, and so a lot of our effort is spent on separating the companies into those two groups. Temperley – Japanese dominant market positions, whether that’s in semiconductor production equipment (SPE) companies like Tokyo Electron, Advantech, Lasertec, or in components – in the component space of ceramic capacitors – have been a key area for Japanese leading global market shares, so companies like Murata and Taiyo Yuden. When I started in the industry in the mid-90s, there was a general concern that Asian companies were going to take market share and the Japanese were going to be toast pretty quickly. Actually, lo and behold, 25 years later, the Japanese are still fighting and maintaining their lead. That is down to a strong depth of knowledge and in terms of intellectual property, fantastic leadership in terms of electronic materials which enable Japanese companies to maintain a lead on their Asian rivals. There still are a number of Japanese companies in the tech space broadly, let’s say hardware, which I’m still confident will be able to maintain their leading positions in facing the global market. Vail – In terms of trends, Japan has many good assets for the new world that we are entering into. Firstly, Japan is very highly geared towards energy efficiency and technology, and then of course, for communications technology, a lot of its products used in work-from-home and 5G trends, which will continue to be strong. Even if there is some slowdown from current lofty levels, there will continue to be growth in the tech sector. It’s also particularly good at environmental controls. More competition is coming into the alternative energy vehicle space that Japan has previously dominated, especially in the hybrid area. It’s maybe put a little too many of its eggs in that basket, and we’ll see what the US and other countries do about giving advantages and stipends for purchasing hybrid cars as opposed to purely electric vehicles. All in all, Japan is very well geared for the ESG future. It is one of the cleanest countries in the world – at least for one that still manufactures things – and it’s got extremely high pollution control standards domestically and overseas.

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