Japan is detaching itself from the global economy and has independent drivers that make it an attractive proposition for investors regardless of outside concerns, according to Comgest’s Richard Kaye.
Kaye, who runs the £1bn Comgest Growth Japan fund alongside Chantana Ward and Makoto Egami, said the traditional view of whether investors should be in or out of Japan needs to be revisited.
“A lot of people see Japan as an all or nothing proposition – they either hold the market perhaps through an ETF or they will have nothing at all to do with Japan,” he said.
“I, of course, do not agree with that premise of investing in Japan – I don’t think it is an all or nothing proposition.”
Japanese equities have been on a strong run in recent years, trending ahead of the wider MSCI World index in three of the last five calendar years.
Last year was a particularly good 12 months for the country, with the Topix index beating the global index by 3.79 percentage points in sterling terms.
Performance of indices in 2017
Source: FE Analytics
However, it is justified, according to Kaye, as the pace of Japanese corporate profit growth has far outpaced the major markets in both the emerging and developed worlds for six years, as the below chart shows.
“You can’t really get this figure if you believe that Japan is just hitched to the US and the global growth story,” he said.
“Japan clearly has some kind of indigenous driver, it may just be forex, it may just be Abe cutting the tax rates but it may also be genuine evolutions like shareholder engagement – companies that have suddenly started to understand about cost control or capital returns.”
The manager said that it is likely a combination of the above factors that has allowed Japan to detach itself increasingly from the global growth story.
“This means that if one were to look at Japan as a standalone then, yes, it can be a very sensible investment candidate whatever you think about global growth,” he noted.
Some of the dynamics that have given Japan its independent drivers come from the well-highlighted Abenomics – the term for the reform programme put in place by prime minister Shinzo Abe – but not all do.
“I think there is a lot of other stuff going on at the same time which is allowing Japan to detach itself from the global growth story,” he said.
Earnings per share (EPS) growth of regions over 6yrs
Source: Comgest
One is that Japan is running out of workers, which has led companies to take a more proactive approach to innovation than those in other areas of the world.
Kaye said: “There is no immigration policy in Japan and certainly not the freedom of migration that exists in Europe or even the US despite all the changes that those governments are trying to make on that.
“Living in Japan and meeting companies in my work life I see this innovation all the time – companies producing software to do what people were previously doing and companies getting by with fewer people using some form of automation instead.”
He added that many traditional industries in Japan have already been forced to consolidate or adapt because of a lack of labour.
“I think that is itself an independent driver that Abenomics probably catalysed but it was there anyway,” Kaye noted.
Another important factor for the Japanese stock market is the Japanese pension fund industry, which the manager said has been an “unprofessional industry” up until recently.
“A lot of Japanese pension funds run internally were run by people who were not life-long investment professionals,” he said.
“Most Japanese white-collar jobs are done on a rotational basis – if you are running pension money there is a good chance that you were selling life insurance policies five years ago and were just rotated.”
Typically, this meant that these professionals were less concerned about outperforming and more worried about not underperforming by too much.
They would typically be benchmark-huggers, Kaye said, which led to underperformance and as such a lack of domestic investment.
However, there has been put in place a new requirement on the Japanese investment industry to do a better job and domestic demand is beginning to shift.
Additionally, this new wave of investment professionals and pension fund managers are demanding bigger things from companies.
“They are saying that managements need to perform and should give dividends, buybacks and a clear business model as a reason to own the stock,” Kaye said.
“They want a selective portfolio – they do not want to have every position in the Nikkei or the Topix and I think that represents a sea change in the thoughts of Japanese investment professionals.”
This, coupled with a lack of labour, is driving changes in the Japanese corporate earning profile and gives evidence that the country is detaching from the global growth picture.
They are also marking a change in the regulatory environment, which Japan has not updated since the second world war.
Kaye said: “Japan has never had the consensus to change it but now for the first time in the post-war period there is a growing consensus of what needs to be done.
“But Japan is running out of time. It doesn’t have enough workers to make things function anymore. A lot of things had to change and this happens to be the moment that they are changing.”
And with Abe at the helm, “Japan has one of the more stable political backdrops of developed markets – and I have never been able to say it until now”, the manager added.
As such, he said that the rate of improvement in Japan – albeit of a low base – has been very good and is sustainable.
Comgest Growth Japan, which the trio took over in 2009, has a quality growth tilt – something Kaye said has been tricky in Japan as there has been a lack of growth and of perceived quality for many years.
Over the past five years, the fund's longest running share class has returned 124.66 per cent in sterling terms, beating the IA Japan sector and Topix index by 59.39 and 55.79 percentage points respectively.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
Currently the fund, which is made up of 40 holdings, is overweight industrials, consumer discretionary, consumer staples and healthcare stocks. It is underweight technology, financials telecoms and materials.
Comgest Growth Japan's sterling share class has a clean ongoing charges figure (OCF) of 0.99 per cent.