Investors are betting on Japanese corporates. In a web debate sponsored by Nomura Asset Management, Global Pensions editor Raquel Pichardo-Allison speaks to Nomura investment specialist Peter Jenkins, Mercer principal Piers Bertlin and Hewitt Associates senior asset allocation specialist Tapan Datta about Japan's turnaround story
Raquel Pichardo-Allison: Peter, what interest are you currently seeing in Japanese equities?
Peter Jenkins: Well quite a lot really. Foreign investors have been putting money into the market. We saw that throughout the last few years. 2008 was an exceptional year, clearly, and we saw something like $40bn come out of the market but since then, fund flows, foreign fund flows, have been very strong. So there does seem to be an appetite by foreign investors for Japanese equities. And certainly anecdotally that is what we are picking up.
In terms of our clients and our prospects, we find increasing numbers of them are looking at increasing their exposure to Japan. I think in the first instance, it is a case of making up for an underweight position, moving back towards a neutral. But as I say there does seem to be a bit of a head of steam developing and I think really as investors look around the world, they see a number of problems that are still there. Clearly the world economy is quite fragile. A lot of the Western world is quite fragile and I think in that context, Japan probably looks an interesting place for which to put one’s money.
Raquel Pichardo-Allison: Tapan, what are you recommending to clients about Japanese equities?
Tapan Datta: Well it’s quite interesting really because the backdrop has not been very enticing. You have talked about Japan’s shaky returns, I think that would be an understatement. It has underperformed very substantially. It is quite interesting that into the upturn in equity markets from about March, April last year, Japan has underperformed and that is actually against a lot of market predictions.
That said, the interesting thing is that particularly from Hewitt’s perspective, from some of our longer term, more contrarian and more sophisticated investors, there is a sense that Japan potentially could be an interesting turnaround story over the next few years and on the whole, we would be inclined to agree. So there is more interest this year, undoubtedly.
Piers Bertlin: It should be said that Japan has over the years waxed and waned and Japan’s size in the world is now relatively small. Japan only represents about 8% of global market capitalisation whereas if you go back 20, 30 years, it was a very much larger stock market in which conscious decisions were made by pension funds, whether to invest or not.
I think the interesting thing about Japan is that it is out of sync with other markets. So when there are fears about the European position for example, that is maybe when Japan will see something of a bounce. Having said which, the long term story has been that Japan has waxed and waned but generally has waned, and this is a market where people do worry about just what the long term holds.
We haven’t seen very much by way of specific new mandates, of people saying we want to appoint a specialist Japan manager, where we haven’t had one before, because we perceive a particular opportunity there. That has been the story looking at our search activity over the last year. If anything, it was lower than the year before that. So we are not seeing a rush in that direction. There is still that question, just where does Japan go in the long run?
Raquel Pichardo-Allison: Tapan, you talked about a turnaround in Japan. What is going to fuel that?
Tapan Datta: Well, I think the ingredients are that Japan has been less damaged in our view by the credit crisis. The eurozone had its own problems. The argument is that Japan has been less impacted by some of the developments that we have seen elsewhere in the last five, six years. And that in terms of valuations, it is now at a level that perhaps investors can afford to take that risk that some sort of turnaround happens, particularly because the new government may bring it about. Now there are huge uncertainties, of course, who knows with these things? But there may be the ingredients of some sort of a turnaround.
One of the things that is quite clear is that before the credit crisis really erupted in the summer of 2007 …some of the achievements were really quite considerable. Now unfortunately, the sheer depth and severity of the recession has obscured some of those gains. But over time, if a modest growth resumes in Japan, the argument is that some of those structural turnaround stories at the corporate level will come to bear and reward investors.
Raquel Pichardo-Allison: Peter, you are nodding your head in agreement, is that what Nomura is looking at as well?
Peter Jenkins: Well absolutely. I think the key thing to remember in Japan as we have heard is that it is really a corporate story rather than a top line story.
There is a lot of potential, as I say, in corporate Japan. Japan has a lot of very good companies in many ways, but returns have clearly been disappointing. One of the things that may well come out of the recent crisis that we have got, and that in fact we are starting to see, is that corporates are really having to get their act together. In many cases in the tradeable goods sector, they have to become more competitive in order just to survive. They certainly have to improve their returns to investors, we are seeing that throughout and there is a great head of steam within Japan for companies to do that.
So I think there is a story there but it is a corporate level story and it is actually quite an exciting story.
Raquel Pichardo-Allison: How does Japan fit within the rest of Asia?
Peter Jenkins: Well certainly I think as far as Japan is concerned, Japan’s economy is almost a two tier or a two stage economy. You have got quite a sluggish domestic economy for a variety of reasons that we can go into, demographics clearly being one of them. But quite a vibrant export sector, external sector. Certainly that is benefiting clearly from the growth in Asia. Japan is a great supplier of things like capital goods to Asia. Nice position to be in; [it would] be wonderful if the UK had somewhere like China offshore as a major customer. But as far as the total economy is concerned, we shouldn’t get too excited because actually trade is quite a modest proportion of Japan’s total economy. Trade is something like 20% or below as opposed to well over 20%, 30% in the case of European countries, maybe 40% in the case of Germany.
So from a wider perspective, it’s nice to have those linkages with Asia but again, the more significant and the more relevant issue is one of the corporate linkages, and we are seeing a lot of corporates in Japan being able to leverage off clearly the growth in Asia.
Piers Bertlin: I think there are improvements happening in Japan. The problem for the investor is that there is such deep seated cynicism because we have heard this story for so long. Ever since Japan hit its peak at the end of the 1980s, we have had, every few years, people coming out and saying this time it’s different. Japan is turning round, it is getting its corporate sector in order, it is becoming more flexible, competitive, all the rest of it and at every stage, we have been disappointed.
I agree entirely that Japan is much more plugged into Asia now and I think that is a positive. Having said which, there are a lot of industries where Japan has fallen behind Asia. Where it used to be the leader in certain technology areas, now it is having to play second fiddle or a specialist where Korea, China, the rest have moved ahead.
So I think one does need to be a bit careful in assuming that this time it really is different. We have seen it all too often. In a way, from an investment point of view, that is the opportunity. I think cynicism is so deep seated and nobody is going to believe it. But actually it is slowly happening.
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