Delano interviewed Sunny Romo from M&G on the factors contributing to the recent performance of the Nikkei 225, a Japanese stock index, over the last several years.  Photo: M&G

Delano interviewed Sunny Romo from M&G on the factors contributing to the recent performance of the Nikkei 225, a Japanese stock index, over the last several years.  Photo: M&G

Soft corporate reforms may explain the revival of interest by domestic and foreign investors in the Japanese stock market. In the first part of a two-instalment series, Sunny Romo, investment director at M&G, discussed these reforms, which have required a change of mindset of corporate Japan.

“The market is starting to recognise that corporate Japan has actually done very well,” said Sunny Romo, investment director covering Japanese Equities at M&G in an online interview on 28 September 2023. “The problem with the Japanese stock market, especially for the foreign investors, […] is the mismatch of timing expectations.”

Making money: not only a western concept anymore

Romo noted that the last “massive leg up” took place shortly after the implementation of Abenomic policies. The mood of foreign and domestic investors turned more positive as they started to expect Japanese companies to become “more profitable and more shareholders friendly.” She thinks that the assumptions were justified, but the journey took longer than expected given the fall of the index from around 20,700 in August 2015 to 14,950 in June 2016.

Corporations knew that they had to earn money, but social cohesion, employment and allocation of capital were the main drivers for management decisions. “[It felt] almost a bit vulgar to say ‘we’re profitable’,” said Romo. The new paradigm “sort of gives companies the permission to seek profitability. It’s a bit of a ‘greed is good’ kind of speech.”

“[Former Japanese PM Shinzo] Abe came 10 years ago and said, it is a patriotic duty to make money […] if the corporate sector doesn’t become profitable, […] our standing in the world [will] continue to fall because our economy [will] continue to fall. That [was] a huge wakeup call,” commented Romo.

Changes in the legal requirements

Romo reported no changes in legal requirements during the interview. Rather, she commented that the corporate governance code stipulates that companies need to think about shareholder return. “You know, in Japan, for anything to change, it has to happen from the soft stuff.” Romo explained that changes must be culturally and societally be accepted to take hold in Japan. She thinks that hard rules and regulations will unlikely change behaviour.

Romo noted that the increased emphasis of the Tokyo Stock Exchange on shareholder return has been a “big driver” for the for Japanese stock prices in the last few months. The TSE was basically saying “if you are not delivering shareholder value, you need to explain it.”

As a large number of Japanese stocks are held by domestic professional investors, there has also been pressure on them to comply with the stewardship code, which basically says: “it’s your duty to actually challenge the company management as well, you’re not just there passively holding these stocks,” said Romo. She noted that there is a record number of proposals from domestic managers communicated to company management, a behaviour that is “entrenched now.”

But how to make money in an acceptable manner?

Romo explained that there weren’t guardrails on behaviours, a corporate governance code, a stewardship code nor proxy voting while the Company Act was last revised in the 70s. These concepts have been gradually put in place over the last 10 years.

Under an “unspoken social contract,” companies are now expected to raise wages but without sacrificing their profitability, as they are permitted to raise prices. Societal acceptance shifted the mindset: “inflation is happening, let’s raise it all together,” said Romo.

It’s like flat, flat, flat, and then it gets socially accepted, and then it goes up in a straight line.
Sunny Romo

Sunny Romoinvestment director M&G

“The early adopters […] have already done fantastically well for Japan,” noted Romo. She thinks that the early adopters have displayed higher earnings growth than the “US corporate athletes” in the last 10 years.

Many companies have gradually followed through in their focus on earnings by looking at examples of others having made the transition. Positively, she thinks that the new focus is now “depoliticised and is sort of, well, truly established.”

NTT, an early adopter of Abenomics

With virtually “no growth,” the national incumbent telecom company NTT has managed “to increased dividend pay-out, each year, in last 10 years […] and bought back 3% [of its shares] every year for the last 10 years,” observed Romo. She believes that it was achieved despite minimal growth but more importantly through increased efficiencies, margin improvements resulting into an IRR (internal rate of return) of 19%.

Another false dawn?

“I genuinely think this time is different, because things have changed structurally,” said Romo. She thinks that we are at a point of no return after accumulating changes. Adoption in Japan is a J curve phenomenon. “It’s like flat, flat, flat, and then it gets socially accepted, and then it goes up in a straight line.”

This article was published for the Delano Finance newsletter, the weekly source for financial news in Luxembourg. .