26 October 2023 (pre-recorded 20 September 2023)
Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.
[NTRODUCTION]
Staci West (SW): Welcome back to the ‘Investing on the go’ podcast brought to you by FundCalibre. This week we dive into the performance of the Japanese stock market. We touch on current opportunities, the shift between growth and value investing in Japan, and the factors that could influence this dynamic in the future.
James Yardley (JY): I’m James Yardley, and today I’m joined by Sophia Li, the fund manager of the FSSA Japan Focus fund. Sophia, thank you so much for joining us today.
Sophia Li (SL): Thank you for your invitation.
[INTERVIEW]
JY: Sophia, the Japanese stock market is always fascinating and it’s been doing quite well this year. And perhaps arguably it’s been more stable than a lot of other markets. So, what has been driving the performance?
SL: This year the Japan market has a strong rally, mainly driven by the re-entry of the foreign investors after they have consistently been selling the market in the past seven years. And then secondly, also due to the concern about the macro risk in China, and the investors in Asia basically consider Japan as a large alternative market to invest in. And then thirdly, also, the domestic economy of Japan is quite stable, mainly because it has been behind the other developed markets in terms of reopening. So, we have the support from the inbound tourists and also the accelerated consumption from the domestic consumers.
Last but not least, the yen actually has been depreciating sharply since earlier this year due to the interest rate differential compared with the United States, and that has benefited the large index components, which usually are the exporters and are more FX sensitive.
JY: And one of those foreign investors which you mentioned is Warren Buffet, of course, the legendary investor who visited the country earlier this year and has been investing and increasing his Japanese holdings. And I think a lot of other foreign investors have been following in as well. So, is this a good sign for long-term investors in Japan? I mean, do you think this money is going to stick around?
SL: Yeah, thanks for the question. So, Warren Buffet has increased his stake in the top five general trading houses in Japan. In fact, he started to invest in these companies since late 2020 when the global commodity price plunged. So this time, he simply just topped up his existing holdings.
Other than that, actually, there’s been some encouraging changes around the corporate governance and also the shareholders’ return attitude among the corporate Japan. For example, earlier this year, actually, the Tokyo Stock Exchange has encouraged all the listed companies in Japan to reconsider the importance of cost of capital and also the efficiency of their balance sheet. And then all of them are required to submit a medium-term strategy to talk about how they’re going to boost the overall valuation of their companies if they’re extremely cheap. And then secondly, how they are going to improve their ROE [Return on Equity]. So, hopefully we can see some encouraging signs of change going forward.
JY: And this is about trying to boost some of those companies which are trading below book value – below the value of the assets on their balance sheet – so, are we going to see an increase in dividends, in things like share buybacks? Is that all happening at the moment?
SL: Of course the media headline just focuses on below one times price to book companies. In fact, when actually we talked to Tokyo Stock Exchange last week, they mentioned that they target all the listed companies, and they actually want to see more response from the higher price to book companies, because so far, they didn’t know that they were the target too. So, in my view, I think the overall corporate governance in Japan will improve and obviously we’ll see more share buybacks and also more dividend payouts.
JY: Well, I mean, that all sounds very positive. And if we turn to your portfolio, and I notice you have GMO Payment Gateway, a cashless payment provider. I mean, this is interesting because only about a third of Japanese consumption is cashless at the moment. So, I mean, obviously it’s a growth area. How quickly are cashless payments now being adopted? And could you give us the reason for holding the stock?
SL: Yeah, thank you. So, for cashless payment, the penetration in Japan, as you mentioned, is very low, as well as e-commerce. For example, the e-commerce penetration in Japan is only about 12%, while in other markets like China, United States, it’s above 20% – 30%. And for cashless payment in other developed markets, it’s already above actually 60%, or in Korea, it’s close to 100%. So the changes are happening in Japan, albeit at a relatively slow pace, but we do think that it will accelerate.
First of all, for GMO Payment Gateway, we like the company because they are the market leader with more than 25% market share in online payment services. And then in the meantime, the company’s also pushing the offline cashless payment. They have a strategic partnership with the largest credit card company, SMCC [Sumitomo Mitsui Card Company, Limited], a subsidiary of SMBC [Sumitomo Mitsui Banking Corporation] Financial Group to install the cutting edge cashless payment terminals across all the major infrastructure in Japan. So, the company has a great track record. Their growth is not explosive, but they have been delivering more than 25% CAGR [compound annual growth rate] growth consistently in the past 15 years, and we think that this trend will continue.
JY: And maybe also just to talk about perhaps one of the negatives in Japan. I mean, there were twice as many deaths as birth last year. I saw today, I think, one in ten people in Japan is now over 80 [years old], so, there is a bit of a demographic headwind. What impact does this have on the economy and more importantly, what impact does it have on your companies? Can they still grow in this difficult environment?
SL: It’s a great question. In fact, many countries in Asia are facing the issue of ageing population. For example, the birth rate in China and South Korea now is even below the level in Japan. [JY: Really, I didn’t know that.] Yeah. And the Japan actually has been a pioneer in terms of dealing with the ageing population. So, in our view, that actually presents investment opportunities to the investors.
First of all, we prefer companies that are able to expand their global exposure. So, basically their growth is not only driven by the domestic economy, but by the overall global economy.
And secondly, factory automation, IT services and software; these are the great tools for the Japanese companies to boost their labour productivity. And then in our portfolio where we invest in a number of these companies which have been growing at a much faster pace than the overall economy.
And then thirdly, we also have been actively looking for ideas which can offer the services to help the elderly people in Japan, for example. There is a strong need for the hospice services in Japan because of the medical budget constraint of the Japanese government. So, we invest in these hospice operators, which can take care of the patients with chronic illness, and also at a much affordable cost. And other ideas also include the job placement companies, which help hospitals, area care facilities look for nurses and care workers. Overall, we don’t think that the ageing population issue is an obstacle to our path to find the growth companies there.
JY: And you mentioned automation there. I mean, Japan, of course, is a world leader in robotics and automation, and of course we’ve now got this big interest in AI as well. So, do you have any robotics or automation-linked holdings? What are the opportunities there?
SL: Thank you. In fact, Japan has been a global leader in this area. Actually, seven out of the ten largest robot makers are based there. And also the country has a very sophisticated supply chain. One of our top holdings is a company called Keyence [Corporation]. They are the largest machine vision system provider in the world, with more than 25% market share. And in fact, that machine vision system is the least penetrated factory automation components, and as a result, we believe that the company can enjoy structural growth going forward.
And since you talk about AI, in fact, actually one of the key beneficiaries from AI is semiconductor production equipment and also materials because they are enabling technology of AI CPUs [ central processing units]. So, in Japan, actually, we invest in a number of niche companies which have dominant market share in the cutting edge semiconductor equipment or materials.
One good example is a company called Ajinomoto [Co., Inc.]. So, this company has some monopolistic market share in a vital type of insulating material used in advanced packaging for AI CPU, called ABF. And for this material, actually right now, more than 60% of demand is from data centres, AI servers. And we believe that it will continue to grow at close to 20% CAGR in the next five to 10 years.
JY: Brilliant. And just finally, Japan is a very stylistic market of course, it tends to swing between the growth and value style investing. Your portfolio, I think is more geared towards growth and quality. So, what are you seeing at the moment in terms of valuations? I think more recently it’s been more of a value market [SL: Yes] which has been a challenge. What could change that in the future and what could make growth and quality come back?
SL: Thank you for the question. So, I think indeed in the past two years, there’s been a strong rotation from the quality-growth type of companies into the financials and the more cyclical companies, which trade at a very low valuation. What happened is that due to the sharply rising global inflation, it’s the companies which had high operating leverage and also which didn’t really have the ability to raise prices in the past that have benefited most because now everyone raises the prices they can enjoy this rally. And in the meantime, because of the high operating leverage, the profit growth has been very strong. So that’s why, for the companies that always have the pricing power high margin, and they can always deliver growth when the overall global economy was weak, they are temporarily out of favour in the past two years.
So, when can these type of companies go back into favour again?
I think that usually they perform well when there’s more concerns about the global economic outlook, and also when yen appreciates because yen is historically considered as a safe haven asset. They tend to appreciate when the overall global economy starts to deteriorate. And for the companies in our portfolio, I think usually their earnings is more resilient during the economy down cycle, and they can always deliver growth which is relatively uncorrelated with the macro environment.
JY: Sophia, that’s been absolutely fascinating. I’m certainly going to be following Japan with interest in the future, and that’s been some really great insights today. So, thank you very much for joining us.
SL: Thank you.
SW: The FSSA Japan Focus fund is a high conviction fund investing predominantly in large and medium-sized Japanese companies, with a heavy emphasis on quality. To learn more about the FSSA Japan Focus fund, visit FundCalibre.com — and don’t forget to subscribe to the ‘Investing on the go’ podcast, available wherever you get your podcasts.
