T. Rowe Price: Japan Equity Strategy
- 13 mins 09 secs
Archibald Ciganer, Portfolio Manager, T. Rowe Price Japan Equity Strategy, discusses the change of stability in Japanese politics, whether he believes the improvement will last when Shinzō Abe retires, what concerns he sees outside of Japan's borders, which market he is most optimistic on, and what stock he would like to own over the long term.
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Why has Japanese politics finally shown a degree of stability and what are origins of Abe’s durability?
The global financial crisis was really the turning point for Japan. So I’ve been living in Japan for almost 20 years and I can’t say the economy has always been doing well, politics have always been stable. But really when the GFC happened I think the establishment realised that it was becoming urgent to accomplish a fiscal consolidation and to deal with a demographic and debt issue in Japan. And that was really the foundation of Team Abe so to speak. So it was the start of ‘Abenomics’ effectively. So of course Prime Minister Abe came along a bit after that but really the process started with the GFC and with the Japanese establishment thinking we don’t want Japan to be the next Greece and so how do we deal with the issue? And then, so this plan was formulated to achieve fiscal consolidation. It was named Abenomics, but really the aim is for Japan to not be the next Greece. And with initial success with the three arrows, I think Abe’s popularity has been good enough that he has managed to stay as Prime Minister. And as a matter of fact he’s on track to become the longest serving Prime Minister in Japan’s post- war history.
Which of his policies have been most successful and most disappointing to his supporters?
I think that ‘Abenomics’, no matter what you read in the press, has been a very big success. Especially in certain fields like labour market reform where Japan used to have very rigid labour laws and labour practices, but these have become a lot more modern I shall say and closer to what western countries have, and we’ve seen a big change in the labour market and in society as a result. Corporate governance is another major area of success. So the Abe administration introduced the corporate governance code for companies and a stewardship code for institutions, and thanks to those two pieces of regulations we’ve seen a big improvement in the quality of corporate governance with Japanese companies again trying to emulate the best practices of other advanced countries. In terms of areas of where success has been more elusive, I think really the main one is the speed of change has probably not been sufficient. For instance, to talk about fiscal consolidation, the consumption tax hike has been postponed a couple of times already. And so progress is real, but progress is maybe coming through a bit more slowly than what people expected.
Why the obsession with inflation targeting and is the BoJ credible when it keeps re-stating a target it’s failed to meet?
The Bank of Japan probably does not believe in its 2% CPI target. The Japanese economy has potential growth rate below 1% and a declining population. It’s very unrealistic to expect 2% CPI inflation. However, I think it’s really important to try and anchor expectations in positive territory in order to help the economy exit deflation. And that’s the true objective of the BoJ and that’s why they’ve been restating the objective even though the CPI is still very far away. So it’s been the right policy and Japan has been out of deflation for four years now, which is a tremendous accomplishment, and thanks to that a lot of reforms have had effect that they would not have had had Japan been stuck in deflation. So it’s critical that the economy stays out of deflation so that ‘Abenomics’ can continue to change and transform the economy.
On the subject of corporate governance, is the effort to improve the focus on shareholders and their returns real or rhetoric?
The efforts to improve corporate governance in Japan are very real. We are seeing a big increase in shareholder returns, dividends and buybacks. Now some of that is cyclical obviously. Japanese companies are making better profits and so they have more profits to distribute to shareholders. But a lot is really structural and is the result of pressure from the government and pressure from shareholders, in particular foreign shareholders. So the government introduced the corporate governance code which incentivises companies to improve their corporate governance practices. We’ve seen for instance the number of independent directors at Japanese companies taking up a much bigger proportion of board seats than in the past, and that’s really a big improvement. So overall the trend is positive. That being said you always have leaders and laggards, and so some companies are embracing change and some are still resisting change. I think that’s where probably it’s important to be an active investor in Japan and to be able to invest only in those companies that are truly embracing change and getting better; whereas a passive investor might have exposure to the whole market and not get the same benefit from better corporate governance.
And do you think improvement will last if there’s an economic downturn or when Abe retires?
So, in the past, one issue with Japan has been that in times of crisis, the economy and politics would improve and fix the situation, but then in good times you would get complacency and efforts to improve would stall. But now things have changed and I don’t think there is any other alternative but to carry on with the reforms. And so I don’t expect, even in a more challenging future, I don’t expect the effort to improve Japan to slow down. And so of course if you have a global economic downturn, it will make things a bit more challenging because the economy might fall back into deflation, at least temporarily, but the drive to reform will remain the same. And likewise when Prime Minister Abe retires, because it’s really a team that is leading, an establishment team that is leading this change, I don’t think one person retiring would change the direction, but certainly might make it more difficult to push reforms through. And so that’s when the issue of who is going to succeed Prime Minister Abe becomes important.
As you look outside of Japan’s borders, what concerns you as an investor?
The Japanese equity market and the Japanese economy are both very sensitive to global demand. In particular in the field of equities, so in the equity market Japan is the most sensitive market to the global macroeconomic cycle. And so if global conditions deteriorate and you have a fall in demand that would be very negative for Japanese profits. And it might be compounded by a stronger yen. As the yen being a safe haven currency, in a downturn you have a flight to quality and a flight to the yen which would compound the negative impact. So Japan is fairly sensitive to the global cycle. That’s a concern to me. Especially if it’s so acute that it pushes the economy back into deflation and that would be a new challenge that Japan will have to face.
Which areas of the market are you most optimistic and skeptical about as you think about positive change and improvement?
The Japanese market has been changing very rapidly. In particular domestic-related companies and industries have shown major improvement, both in terms of the quality of the business and also the quality of fundamentals, and there’s also a very large number of smaller companies and startups that are emerging in Japan and creating new services and stimulating economy growth. So that’s a very fertile area for active investors to find attractive opportunities. On the flipside, a large proportion of Japanese companies are involved in traditional manufacturing, and these companies and sectors are under secular pressure from low cost countries such as China. And we’re seeing China moving up the value chain and challenging more and more of these manufacturing industries. I think that for a large proportion of the market, these Japanese companies are going to really struggle to maintain their competitiveness over the medium to long term and might struggle to deliver good returns for investors.
On the bear case for Japan, can anything reverse the magnitude of its shrinking workforce? What does an aging society mean for you as an investor in Japanese equities?
I think there’s a sense of fatalism about Japanese demographic trend, with some people saying that it’s very difficult to invest in Japan because of the poor demographics; however, two things are important. The first one is that the country is addressing these issues. So first of all we’re seeing a big increase in immigration in Japan. Even though it’s not called immigration, it’s actually very real. And second, Japan is going probably to raise the retirement age to 70 years old and will be first country in the world to do so. I think just these two factors would alleviate the shrinking workforce issue and the ageing of the Japanese population, probably not reverse but alleviate the issue. And the second aspect is that even in a country with such a demographic profile, you can find attractive investment opportunities with companies that benefit from this trend. So, for instance, my strategy seeks to invest in companies that improve the efficiency of healthcare companies, so for instance hospitals in Japan, by providing services that help save on labour and improve productivity. And that’s obviously a big benefit to investors to be able to pursue these opportunities.
Can you give an example of a holding which highlights your investment approach?
I would like to highlight one company, one stock, and that is SoftBank. Very large cap, very famous company, they are one of the largest shareholders in Alibaba. They control Sprints and they also control the third largest telecom company in Japan. On top of that they have a very broad portfolio of attractive tech companies. A couple of years ago SoftBank acquired ARM, which is a UK company involved in chip design, and that has very bright future in with IOT. SoftBank has a very attractive long-term portfolio, is very well run with probably the highest management quality in Japan and I think is a very solid long-term investment.
Risks - the following risks are materially relevant to the strategy:
Currency risk - changes in currency exchange rates could reduce investment gains or increase investment losses.
Small and mid-cap risk - stocks of small and mid-size companies can be more volatile than stocks of larger companies.
Style risk - different investment styles typically go in and out of favour depending on market conditions and investor sentiment.
General Portfolio Risks
Capital risk - the value of your investment will vary and is not guaranteed. It will be affected by changes in the exchange rate between the base currency of the portfolio and the currency in which you subscribed, if different.
Equity risk - in general, equities involve higher risks than bonds or money market instruments.
Geographic concentration risk - to the extent that a portfolio invests a large portion of its assets in a particular geographic area, its performance will be more strongly affected by events within that area.
Hedging risk - a portfolio's attempts to reduce or eliminate certain risks through hedging may not work as intended.
Investment portfolio risk - investing in portfolios involves certain risks an investor would not face if investing in markets directly.
Management risk - the investment manager or its designees may at times find their obligations to a portfolio to be in conflict with their obligations to other investment portfolios they manage (although in such cases, all portfolios will be dealt with equitably).
Operational risk - operational failures could lead to disruptions of portfolio operations or financial losses.
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