We interviewed Kwok Chern-Yeh, Head of Investment Management at Aberdeen Asset Management in Japan. Chern moved to Tokyo in 2011 from Singapore, where he had worked in management since 2005. Aberdeen currently has a team of 6 people dedicated exclusively to investing in Japanese equities, supported by an Asian equity team of 38 investment professionals located in 10 offices spread throughout Asia and teams around the world.
Why should investors look at a country with a challenging macro environment?
Japan is the second largest individual market worldwide, after the United States, by number of listed companies. This is a very large market with leading companies which are global leaders in their respective industries and very well managed. If we look at the Japanese market, we see it has great depth. It consists of 3,000 companies, of which 1,900 are listed on the first section. Among these, we selected a very small number of well-managed companies with strong and healthy balance sheets and with respect for shareholders. We manage very concentrated portfolios. Both the Large Cap and Small Cap strategies have fewer than 40 companies.
The investor must differentiate between Japan's economic situation in general and the situation of individual companies. In regards to macro data, there are two facts which for the time being are not expected to change. First, we have the fastest aging population in the world, because life expectancy is rising, and the birth rate is still very low. And secondly, we face a high government debt and a persistent deflation problem. In regards to this second issue, there are certain sections of the market where there is obviously no pressure on prices, but in others, where there are players with considerable market share, a rise in prices is possible.
But if we analyze the micro data, things are much more interesting and different. Unlike the government, companies have large cash flows, and also currently, their growth is not dependent on the Japanese economy. They are multinational companies in which less than 20% of their business is concentrated in Japan. These companies have been increasing their incomes from abroad for some time, and this circumstance enables companies to benefit from growth in other parts of the world, especially in Asian emerging markets with rapid growth, in which the middle class is driving the demand. In addition, many of the best companies have begun to outsource their production to countries with lower-costs. Aberdeen’s objective is to select those companies that are the best performers in a struggling economy.
How does the currency effect affect the results of the export-oriented companies?
The stocks in our portfolios have international exposure, but need not necessarily be exporting companies per se. Many of our companies outsource production and sales outside Japan, this is important from the currency point of view, since this part of the business is not affected by the strength of Japanese currency since production costs are not in yen. The only currency-effect we could find in this case would be at the time of transferring benefits to yen. However, high-end production is usually located in Japan and this section of business itself is affected by the currency effect. Japanese companies are comfortable with an exchange rate of 100-115 yen vs the dollar. With an exchange rate below 100 yen per dollar, it is more difficult for these companies to make money. Regarding the RMB its devaluation does not have to be a problem either for companies that produce in China, which are many nowadays.
Regarding portfolio composition, do you seek the same sectors for Small Cap strategies than for Large Cap strategies?
No, in reality, the opportunities that can be found in both strategies are different, for example, in the Large Cap strategies, there are some good options in automotive companies, while in Small Cap strategies, the most interesting companies are those that produce automotive parts. Another example would be pharmaceutical companies, which are attractive to Large Cap strategies, while for Small Cap strategies we focus more on companies which produce medical devices and equipment.
Is there any improvement taking place within the corporate governance of Japanese companies?
In general, we are feeling encouraged because new measures and improvements in corporate governance are being implemented, but they are still insufficient and the process is very slow. The main problems facing foreign investors have been, and still are, the shortage and low efficiency of the information provided by companies, not looking after shareholders, and not taking into account their profitability, as well as maintaining very high cash levels.
The new corporate governance code based on the OECD’s Principles of Corporate Governance, which came into force in June, aims to address these problems. Regarding the quality of the information provided by the companies, it is still inadequate, and should be expanded. Something similar is happening with the relationship between companies and shareholders. Some companies are taking steps to support this good interaction, even exceeding regulatory standards, and on occasions, legislation itself is later responsible for adjusting these measures. Finally, the problem of excessive levels of cash in companies should be addressed. This is a long-standing problem, motivated by economic events of recent decades. After the banking crisis in the eighties, banks endeavourednot to grant credit to businesses, which led companies to adjust to growing without debt, and to have high amounts of cash on their balance sheets. Companies believe they need this cash because for a long time they were denied credit and now don’t know how to work otherwise. It is clear that these reserves should be returned to shareholders, but this practice will take a long time to become effective.
What are the difficulties that an analyst or investor may encounter when investing in the Japanese market as compared to other markets? Why is it good idea to invest in Japanese companies?
I believe that there is no substantial difference between investing in the Japanese market or any other market such as American or British. Perhaps the greatest difficulty we encountered in the Japanese market is, as I said earlier, that the information offered by companies is not very efficient. The Japanese economy is the second largest by market capitalization; however, the Japanese stock market has not been sufficiently covered by analysts: only 14% of assets invested in Japan correspond to companies with analyst coverage, compared to 71% in Asia-Pacific ex-Japan. This situation favors us because Aberdeen has been analyzing Japanese companies first hand over the past 30 years, and we have been able to find very good opportunities.
An example of these good opportunities in which we have invested and are still investing, are companies with great market capitalization in which dividends have grown substantially in recent years. Companies with stable ROE and EBITDA, strong balance sheets, and good fundamentals, and which do not depend on the evolution of the domestic economy. These are the type of companies in which Aberdeen invests for their Japanese strategies: quality companies, even if it involves having to pay more for them in some cases, because in the medium term, returns exceed the benchmark. If we compare the average P/E of our strategies with the benchmark, we will see that ours is higher. But this should not lead to confusion, because the benchmark is weighted down with very low PERs from banking companies and the automotive sector, and may seem cheap, but it really isn’t, as structurally, these sectors are trading at very low ratios.
What are the technical factors that will affect the Japanese market during the coming months?
In July, we have elections in Japan for the Upper House. Shinzo Abe is trying to reform the economy but has another intention for the long term, which is to reform the Constitution, and for that he needs votes, time, and to gain in popularity by presenting a package of measures to stimulate the economy before the elections, since the Abenomics plan has not worked as it was initially intended to, and the economy remains weak.
And, in regards to the restructuring of the pension funds, is it stimulating investment in Japanese equities?
The GIPF, the world’s largest pension fund, (the Japanese government’s pension fund) has already adjusted its allocation in Japanese equities raising it from 12% to 25%. If small pension funds did the same, it would lead to an increase in investment in Japanese companies in the short term. This remains to be seen, but normally these pension funds often operate by following the steps of GIPF.
How have Japanese investors been acting in recent years?
The Japanese domestic investor mentality is changing very gradually. When markets rise, they feel encouraged to invest in Japanese equities, but the proportion of their wealth in these assets is still very low.
And Latin American and US Offshore market investors?
Japan has been ignored by foreign investors for many years, it is an educational issue. The Latin American investor currently has around a 5% exposure in the Japanese market, the US Offshore investor, however, has been more receptive during the last two years, but despite this, Japanese exposure is not higher than 10%.
Is it possible for the international investor to cover yen fluctuations in the strategy’s net asset value?
Although these strategies are denominated in yen, there is a class denominated in dollars (hedged) which covers the currency effect, and which is the most popular for Latin American and US Offshore market investors.