The Nikkei 225 broke 37,000 for the first time in 34 years on 9th February, but the index is just one of several indicators that suggest Japan’s investment landscape has turned the corner. Structural reforms, changing dynamics, and a corporate governance revolution with a new focus on improved returns on capital unique to Japan are starting to take hold say James Salter and David Mitchinson, managers of specialist Japanese investment boutique, Zennor Asset Management.
Five key indicators
• 34 years since the Nikkei 225 broke through the 37,000 level
• 41% per cent of Tokyo Prime companies have confirmed they will address undervaluation
• 26 MBO announcements in 2023 – the highest for a decade
• 54% of Japanese listed stocks have net cash on their balance sheets
• 3.2% Japanese CPI in 2023, with inflation returning following decades of deflation
Following new guidelines introduced by the Tokyo Stock Exchange (TSE) last year, Japanese companies have begun to restructure to focus on capital allocation and a return on invested capital. At the turn of this year, the TSE reported that 41% of Tokyo Prime companies had announced steps to address undervaluation or were contemplating the cost of capital. The TSE also recently wrote to more than 2,000 companies to establish whether their existing operational and governance structures remain fit for purpose.
MBOs in Japan accelerated last year at their fastest pace for 10 years; there were 26 MBO announcements in 2023, with a combined value of $2.4bn, according to data from LSEG – and the pace of such activist events is likely to continue. Unlike their Western counterparts, many of Japan's companies are awash with cash and able to meaningfully increase dividends. More than half of Japanese companies listed on the Topix have net cash on their balance sheets compared to around 20 per cent of companies on the S&P500 and FTSE All-Share.
James Salter, CIO and manager of the Zennor Japan Fund said: “Change is happening – and so far, the biggest changes have been at the firms that very few investors have cared about for many years. For those looking at Japan from afar, it is difficult to appreciate how cheaply valued companies are; how asset-rich firms are; how poorly focused they are on core business activities; and how inefficiently they use equity capital compared to those in Europe, let alone the US. As firms address these challenges, they will spin off dramatic quantities of free cash flow which we believe will be returned to shareholders.
“There are challenges – the US recession would have a detrimental impact for instance, but Japan has much to offer patient investors. It has it all. Buybacks, higher dividend pay-out ratios, MBOs, tender offers, and now domestic activists are joining foreign investors in demanding change.
“From a bottom-up perspective rich pickings are there to be found in mid and small-cap shares, as more than half of the listed market in Japan has virtually no analyst coverage; this means that true specialists in this market will have opportunities to add significant alpha. And, as interest rates rise, the yen will strengthen, enhancing returns for UK investors.”
The £455m Zennor Japan Fund aims to generate capital growth by investing in shares that trade below intrinsic value and offer upside potential, triggered by a catalyst.
The management team of James Salter and David Mitchinson leverage their extensive network in Japan to help uncover under-researched companies across the market capitalisation spectrum, often finding the most promising opportunities in smaller companies.
