The Nikkei 225 has enjoyed a covid recovery over the past three years, like many other world stock indices. It has continued its run, hitting 32,300 (as of 13 October 2023). It has almost doubled since the low point (around 16,500) reached in March 2020.
What are the diversification benefits for a European investor?
“I can understand why [the S&P 500] is on a high valuation, […] however, it is an extremely concentrated index [...] Where else are the developed markets? You’ve got Europe, and you’ve got Japan,” said Sunny Romo, investment director covering Japanese equities at M&G in an online interview on 28 September 2023.
Japan has become a growth play emerging from a value play, a label that applies to European stocks nowadays, according to Romo. Indeed, M&G expects mid-teen returns from earnings and for shareholders during the current decade.
Downside risks are mitigated by the fact that Japan is a developed market “with tonnes of IPs [intellectual property] and unique businesses that are globally relevant,” coupled with a “pretty cheap” currency compared to historic exchange rates (euro/yen is currently at 158 versus 116 in April 2020), corporate reform tailwinds, companies with “very strong” balance sheets and the rule of law.
Surprisingly, Japanese exporters underperformed over the year, despite the weakening of the yen. Banks are the stocks that outperformed despite the sticking low rates. Romo believes that this market behaviour may be explained by the expectations that a normalisation of rates, resulting into a smaller interest rate differential, will push up the value of the yen.
M&G’s stock ideas
NTT, the national incumbent telecom company, may not only be attractive for its income features, as . She thinks that the company may be at the forefront of the development of the next generation of semiconductors. Romo opined that their IPs in the optic space could have “significant value” which currently represents a “free optionality.” NTT was one of the ’s 10 largest holdings, as of 31 August 2023.
They’re doing the right things [but] they’re not quite making the right disclosures, so they get discounted.
Sanrio Company, an entertainment company best known for the Hello Kitty brand, focuses on the kawaii segment of Japanese popular culture. The philosophy of the previous founding chairman was “to create smiles, not money” with a repertory of “cute” characters. Romo pointed to the change of management and philosophy with the new CEO focusing on profitability. She thinks that monetising Hello Kitty globally has “a lot of upside potential.” M&G’s Japan fund holds a position in Sanrio.
Lastly, Seven & i Holdings, a Japanese diversified retail business known for its 7-Eleven convenience stores, recently acquired Speedway, in the US, a transaction that has “put them on the map.” Seven & i represented roughly 5% of total net assets in M&G’s Japan fund, as of 31 March 2023.
Japanese firms and ESG: a long way to go
Romo thinks that the weak MSCI (Morgan Stanley Capital International) ratings reflect poor disclosures by domestic firms. “They’re doing the right things [but] they’re not quite making the right disclosures, so they get discounted,” observed Romo.
The ESG rating agencies are seen as not assigning enough resources in Japan and she thinks that they are not reading disclosures written in Japanese. Despite helping companies with their disclosure, she acknowledged that Japanese firms are ESG laggards.
Fund management approach
The M&G (Lux) Japan Fund is “style agnostic,” aiming to generate, as a minimum, the performance of the benchmark. Alpha is generated through a stock picking approach with a great consideration to risk management. “We look at good companies, bad companies, growing companies, shrinking companies, they’re all part of our research universe, because we know these characteristics flip from time to time.”
The fund is classified as an but “we are not running an ESG fund,” said Romo. Yet, she stressed that they do “engage with companies a lot.” M&G will not refrain from giving advice or putting pressure on companies to change course.
Headwinds to be expected in the short term
Romo categorically does not think that “people have missed the boat […] as Japan has several years of growth stories [in front of it].” After discussions with foreign investors, she assessed that many of them do not want to get short or be underweight on Japan.
Yet, the eventual Bank of Japan’s exit from negative rates, as inflation is finally taking hold in the country, “is a really good story in the long term.” However, Romo expects these developments to create “some jerky movements” in the market creating “entry opportunities for a market which has “several years to run still.”