Investing in Japan will get harder in 2014
17th February 2014 17:28
Many readers will be unaware of the remarkable fact that, by value, the market in Japan for infant nappies is worth roughly the same as that for incontinence products for adults.
Many will similarly know that this is because Japan has one of the world's lowest birth rates, and a population that is ageing faster than any other country on earth.
To a fund manager, these two things represent an opportunity to make money. Step forward Kwok Chern-Yeh, head of equities at the Tokyo outpost of Aberdeen Asset Management. One of the key holdings across Kwok's various Japanese funds is Unicharm, the leading maker of these nappy products. However, he holds the stock not simply because of domestic realities.
For well over a year now, military and political tensions with China, primarily concerning sovereignty of the Senkaku Islands (or Diaoyu Islands, as China calls them), have meant costly problems for Japanese companies - particularly car manufacturers, which saw falls in sales of 40% - as large numbers of Chinese consumers shun Japanese goods.
Moreover, Japanese companies barely figure when state-owned Chinese enterprises call for international tenders, where blatant preference is given to businesses from the European Union, US, or anywhere but Japan. Yet the attractions of Unicharm's products rise above such issues.
China's (now outgoing) one-child policy, says Kwok, means the Chinese tend to indulge this sole child.
"They see that these nappies are made in Japan, and this is considered a stamp of quality. Nationalistic sentiments get set aside."
Kwok Chern-Yeh
Age: 37
Position: Head of Aberdeen's Japan team, in Tokyo. Funds include Aberdeen Global Growth fund, Aberdeen Japan Smaller Companies fund and Aberdeen Japan investment trust.
Education: Anglo-Chinese Junior College, Singapore; BA in Journalism, University of Missouri- Columbia; MSc in Finance, London Business School.
The past: Business reporter, St Louis Post-Dispatch, for three years. Joined Aberdeen in Singapore Home: Tokyo. Wife. Literature and jazz.
Finances: Aberdeen funds
Weakening boycott
As 2013 drew to a close, there were signs that the boycott was weakening.
And then, on Boxing Day, right-wing president Shinzo Abe made his look-at-me visit to Japan's shrine to its war soldiers. One of the country's leading newspapers, Asahi Shimbun, attacked his bravado and said business leaders, fearing a renewed backlash by Chinese consumers, had lobbied against the visit.
Now, predictably, Chinese media are having a field day with new waves of anti-Japan rhetoric. After the stellar rise of almost 60% by the Japanese equity market in 2013, this year was always going to be a challenge.
In turf parlance, Abe's outing means the going will become even more testing. As Kwok says, the Chinese economy "hasn't been that strong, and the global economy is still trying to pick itself up".
For Kwok, the great revival in the Japanese market has proved rewarding but "tricky". Fourth-quartile performance over the past 12 months by his two Japanese funds, and , follows several years of outperformance. (In addition, last year he was handed what had been Aberdeen All Asia investment trust, after it changed its mandate to focus only on Japan.)
The slippage is explained by the fact that Kwok follows the Aberdeen template. This, broadly, means sticking to a philosophy regardless of market conditions - focusing on stable companies that are readily understood, have honest management, are accessible to analysts' visits and have strong balance sheets.
Index-driven buying
"There has been a lot of liquidity and a lot of thematic buying. Some of the poorer-quality companies have done extremely well. Why? Walls of [foreign] money came into the market in a short period of time and a lot of these investors were index-driven. The larger stocks and the most liquid stocks have done well. But, over many years, the largest and the most liquid haven't been the best to be in.
"The largest component of the Nikkei 225 index is Fast Retailing - the Uniqlo group. It has a weighting of around 9%, and the index-driven money means it has done very well. The weaker yen means [the company's] margins will be lower - yet the stock is trading on a price/earnings ratio of around 40. Compare this with other main retailers around the world, where the ratios are in the high teens or low 20s," says Kwok.
Japanese banks have also done very well, he continues: "But Japan remains an over-banked country, competition is very tough and loan demand is weak. Some banks haven't done very well for many years, and at the consumer level, funding has been anaemic for years," he adds.
As a former journalist, perhaps Kwok does not have the ever-sunny optimism that many fund managers can muster. Abe's stunning bid to end decades of deflation by printing money to debase the currency and lower exchange rates, increasing consumer taxes and much else, might have international investors on the edge of their seats, but Kwok is more reflective.
He says: "Abe's approval ratings have been declining. The new State Secrets Bill is not popular. What is a state secret? It hasn't been defined. There is also a view that Abe hasn't been focusing as much on the economy as he said. Japan has had a difficult economy for years, but the long-term implications of Abenomics are not properly thought through.
"The rise in energy costs because of the earthquakes and a weaker yen, for example, is not good for business. The stockmarket might have seen strong gains but does much filter down to the population? Real estate prices are picking up, but the consumer tax will soon rise from 5 to 8%, and then to 10% a year later."
Wages still stagnant
Wage growth is crucial to the prosperity of all economies but, right now, especially that of Japan. "There has been an increase in bonuses [winter and summer bonuses are a feature of life for Japanese workers], but not wages," Kwok observes.
Indeed, wages in Japan are expected to rise by just 0.6% this year, and much of this will be negated by the 66% rise in consumer tax. The IMF expects 1.2% growth in GDP, and this makes for corporate nirvana: more government money, a depressed yen, an asset bubble and virtually stagnant payrolls.
"Abe has done a good job in reviving the economy, but the biggest test of all is structural reform," says Kwok. This is one of the so-called three arrows in Abe's quiver - the others being monetary easing and fiscal stimulus.
To find out if 2013 brought an end to two lost decades for Japan, read: Abenomics key for Japan's economy in 2014.
"Over time, the typical view of corporate Japan that has emerged is of companies with strong balance sheets - in other words lazy balance sheets, with lots of idle cash - poor corporate governance and a disregard for shareholders," says Kwok.
He implies this, in the main, is still the case. Takeovers are still a foreign concept and companies, for instance, do not have to release the detail of votes taken at annual general meetings beyond the bare result.
"There is a lack of independent directors and corporate life is still pretty cosy. While dividends have been increasing, the rises come from a low base," he says. "Many companies haven't grown for years and there is a lot of inefficiency. Regulations make it hard for a company to fire someone, so many are reluctant to hire."
The grip on consumers by retailers and Big Pharma is about to be tested, he says, by a new company selling over-the-counter drugs online. But an even bigger target for the government is the removal of certain tariffs, particularly those that feather-bed farmers. Imported rice, for instance, attracts a tariff of almost 700%. When and if it's lowered, cheaper food prices will help compensate for higher consumer taxes.
"The cost of labour and the cost of doing business in Japan is high, and this is why so many companies are expanding outside the country. This helps lessen the effects of a weaker currency. China is the most obvious place to expand, as a lot of demand comes from there; but many companies, such as Makita, are also expanding in Thailand and Indonesia."
For the coming year, Kwok has two main concerns: "The global economy is still stop-start. The weaker yen has helped, but wheredo we go from here? When we look at the companies we are invested in, we are pretty comfortable. They have faced more testing years.
"My other concern is market-specific stuff. Lots of liquidity might have come in to Japan, but liquidity can go out as well. Will this hot money stay when, or if, things aren't that favourable?"
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