Outlook for Japanese Equities

Peter Jenkins, Client Portfolio Manager at Nomura Asset Management, discusses his outlook for Japanese equities in 2018, longer term investment incentives, approach to analyst coverage and how investors can access Nomura's Japanese equities capabilities.

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  • 11 mins 52 secs
PRESENTER: Joining me now to discuss the outlook for Japanese equities is Peter Jenkins who’s the Client Portfolio Manager at Nomura Asset Management. Well Peter it’s good to have you with us today.

PETER JENKINS: Good to be here.

PRESENTER: So 2017 was a good year for Japanese equities, so what’s your outlook for the months ahead?

PETER JENKINS: Well we’re speaking at a time clearly when we’ve seen a bit of an uptick in volatility in markets. But that notwithstanding we’re still upbeat for Japan going forward. Certainly over the next few months there are a number of key structural issues which we think favour Japan. One of which is that in terms of monetary policy we see little change from the Bank of Japan. I know investors around the world are getting concerned about higher interest rates. And clearly we’ve seen the Fed start to tighten, the Bank of England, and we’ve started to see the ECB move towards tapering. But we think that in Japan the Bank of Japan will keep monetary policy just as it is, so it’s going to remain loose.

We see fiscal policy as being supportive as well on the basis that we see corporate tax reductions, and that’s currently being discussed for the next budget. Political stability, the Abe government has recently won an election. He’s there for some time. So the background from that point of view is good. From an economic point we’re starting to see some better numbers come out of Japan. The production numbers have been very strong for a little while, but now we’re starting to see a little bit of strength. Early signs, early days but we’re starting to see a few signs coming through that in the domestic economy there might be a little bit of a pickup, and if we see a reasonable spring wage round, wage increases in the spring, then we could see consumption boosted further.

So the general background is good, but really what has been driving the market over 2017 and we think well into this year is the earnings picture. Japanese companies have produced some very strong earnings over the course of the last year. They have benefited from the fact that we’ve seen relative stability in terms of exchange rate movements. They’ve benefited also from the silicon cycle, from an uptick in global demand generally, and we’re starting to see some good numbers coming through initially in the exporters but moving increasingly in domestics. So overall we’re looking for earnings growth in this fiscal year to the end of March of something like 20%, with between 8% and 10% over the next two years. And this, we’ve seen earnings results as they’ve come through have been exceeding expectations for the last six months, and we suspect there might be some further upside going through.

So it’s really an earnings-driven market from that point of view. And we think that continues certainly as I say through to the next reporting season, which will be the full year reporting season in April or May. And set again that valuations are pretty reasonable. Japan is one of the few markets where the gains of last year in terms of the market didn’t cause a significant increase in valuations, basically because corporate fundamentals kept up with the movements in the market. So again there’s been very little multiple expansion over the course of the last year, which again gives us a base to work on as we move into 2018.

PRESENTER: And looking at longer-term investment incentives, such as corporate governance, structural changes, anything to note there?

PETER JENKINS: Absolutely, I mean and we think actually it’s the longer-term incentives that are really what will drive Japan over the coming years. And the key thing is Japan is the fact that corporate, there’s a lot of pressure on companies to improve their overall return structures. In the past, Japanese companies have produced pretty poor returns, returns on equity typically peak cycle of about 10%, half the levels that they are elsewhere, as a product basically of the Japanese style of capitalism where shareholders were only one of the stakeholders in a company and companies weren’t necessarily being run to maximise profitability. But both the government through various bits of legislation and also investors are pressurising companies to improve their returns, and this is as I say a very strong and I think a very powerful investment theme going forward. And indeed Japan is one of the few places where if the top line were flat, if revenue growth were pretty flat going forward for the next few years, we could still see bottom line growth from an improvement in corporate efficiency and corporate returns.

PRESENTER: Now around the world there has been a clear trend for investors to move to passive vehicles as they look to cut costs. Do you think this is a sensible approach to Japanese equities?

PETER JENKINS: Well we think Japan is one of the few markets where there is a clear case for active investment. And the reason being is that Japan is a very inefficient market. Analyst coverage is very poor. If you look at TOPIX for example, which is the top half of the stocks by number in terms of total listed stocks in Japan, and it’s approaching 2,000 names. Even if you look at TOPIX, which again as I say is only the top half of the market, something approaching 60% of companies in TOPIX are covered by two analysts, one analyst or no analysts at all. So there’s a great deal of paucity of coverage as far as the market is concerned, which gives us opportunities to find attractive stocks within that. So that’s the first reason.

The second reason is - this goes on from what I was saying earlier - that there’s a very clear long-term investment theme, which is the improvement in corporate returns. And this is going to be played out very much at a stock level stock by stock. Some companies will embrace this new world, others won’t. And we think it’s important to focus on those companies that are embracing this brave new world and are focusing on returns. So as I say you’ve got an inefficient market related mainly to the lack of coverage and secondly you’ve got a long-term investment theme. So we think put these two together and that should be fertile ground for active managers.

PRESENTER: And do you favour any broad investment style in this market?

PETER JENKINS: Certainly around the world there’s been a lot of discussion amongst managers about whether they should follow a value or a growth-based approach. As far as we can see in Japan there are merits in both approaches. We were talking earlier about restructuring corporate change in Japan, lifting overall returns. This is very much a value story. It’s finding companies that are performing poorly and that are going to change the way they work, the way they operate, their profitability over the years. As I say that is essentially a value story. So there are good things there. But we also see, when we look at some of the growth companies in Japan, some of those companies that are reporting strong returns and admittedly trading at slightly elevated valuations by virtue of that, we still find there are inefficiencies in that area of the market. And the key inefficiency there is that for many companies, investors assume that returns above average for the industry for the market will gradually fade back to normal. But if we can identify companies where that reduction in returns happens more slowly than the market thinks, or indeed doesn’t happen at all for the medium term, then there is upside in those companies being revalued. So we see opportunities in both parts of the market.

As a house we had initially a value-based sort of backdrop, but increasingly we’re seeing interest in some of the growth parts of the market. Also as well I think it’s worth pointing out that if you avoid all the growth stocks, and focus entirely on value, that rules out a lot of the new economy stocks, the internet stocks and so on and so forth which investors might want to include. So we have strategies that deal with both. Effectively we go to where the inefficiencies are within the market, that’s how managers make money, and there’s some on the value side and some on the growth side.

PRESENTER: Now Japan is well known for not having in-depth analyst coverage. So at Nomura Asset Management, I mean how do you approach that?

PETER JENKINS: We have our own team of analysts. We have our team of in-house analysts. We have about 24-25 analysts in total, each covering 25 to 30 stocks. We think that’s vital in a market where general market coverage is quite poor. Clearly we can use analysts that work in the industry generally, but the core of our research approach is our in-house analysts. They cover as I say in total something over 700 stocks. Every stock that goes into a portfolio will be looked at by an analyst as well as a portfolio manager. And indeed every stock that’s in the portfolio will be looked at also by the portfolio manager and the analyst. So they’re good for finding stocks but also for risk control, mitigating risks and reducing risks when stocks are actually in the portfolio.

Our analysts are career analysts. They will tend to remain within that area for their whole careers, they can be promoted within that, and in total it’s a very experience and very useful team. I think on average the level of years of experience for individual analysts is something like 18 years. So it’s a highly experienced team. But as I say we think it’s a necessity in this market, necessity to have a very strong research base and also a very strong disciplined process to operate in conjunction with that.

PRESENTER: And finally what strategies are you seeing inflows, and indeed how can investors access Nomura’s Japanese equities capabilities?

PETER JENKINS: Well we’re seeing inflows from a number of funds, but we have two primary UCITS flagship funds. We have the Japan Strategic Value Fund, which is a $1.5bn fund. And that is focusing on the value situations, the turnaround stories. That deals with that part of the market, that sort of inefficiency that we were talking about earlier in terms of turnaround stories, finding those companies. But in addition to that we have another UCITS fund which is finding favour called the Japan High Conviction Fund, which actually comes at the topic from more of a growth viewpoint, i.e. it looks at those companies that have strong returns that are likely to maintain those returns for longer than investors think so therefore we’re seeing an uplift in valuation. That is a smaller fund in itself, that’s something like $50m, but it is the tip of an iceberg because we have a larger mothership fund as it were in Tokyo of well over a billion dollars in that particular fund. And those are as I say two areas to exploit those two inefficiencies in the market, both in the value space and also in the growth space.

PRESENTER: Peter, thank you.

PETER JENKINS: Thank you.