Dr Samuel Barbosa Da Cunha is the CEO & Chairman at Bar Trading Japan looks at how the changes in corporate governance are impacting investment opportunities.
Japan’s stock market growth has defied general expectation. Interest from overseas is growing for Japanese equities and the stock market is buoyant. So, why do more and more investors want to trust their money in Japan?
It’s often said that Japan is a cheap market, or that it’s cyclical. At the end of 2020, people were pointing towards Japan’s relatively good COVID-19 performance – something that has shifted somewhat in the first half of 2021.
And while some of these reasons are valid, investors should be thinking beyond a 12- month view. Savvy investors are thinking long-term and considering Japan’s market on the basis of a five- or ten-year investment plan. The major reason to invest in Japan is the revolutionary changes within corporate governance.
Corporate governance changes impacting Japanese stock market
For anyone who has invested in Japanese equities for years, the changes surrounding corporate governance are unprecedented. Beginning in 2014 with Prime Minister Abe’s new stewardship code and corporate governance code, the changes have ramped up ever since.
If we compare Japan with the UK during the height of the first wave of the pandemic, we can see stark differences. In the UK, companies were told to cease dividends in major sectors, such as banks and oil. Japanese companies, on the other hand, were shored up by strong balance sheets. More than half of Japanese companies have net cash on the company balance sheet, compared with around 15% in the US and Europe.
The number of external directors working with Japanese companies is rising all the time. And companies are fully embracing welcoming activist investors onto their boards to help them move forward. This just wouldn’t happen even ten years ago. Many companies are reducing the number of their directors. Still others are taking on board environment, social, governance (ESG) tenets. All of these changes are progressing and we’re still in the very early stages of a fundamental revolution that will take a number of years.
It’s also the case that the external image people tend to have of Japan is different to the reality, and this impacts Japanese equities. The media impression of Japan tends to revolve around depictions of Tokyo with lots of people and evidence of forward-thinking technology everywhere. And while this is true about some regions of Japan, it’s not hugely representative of the country as a whole.
Japan lags behind the rest of the world in digitisation and online automation
In some ways, Japan remains behind the rest of the world in terms of progress. For example, the absorption of cashless transactions and ubiquitous e-commerce are at the start of their journey in Japan, while obviously in much of the rest of the developed world it has taken a strong hold already.
Japan was at the cutting edge of consumer electronics in the 1980s, but this didn’t future-proof them through the ensuing slump. Whether the big names of the boom times will last through the next 20 years remains to be seen. Japan is a market with more than 4,000 listed companies with little mainstream coverage. This means huge opportunities for investors who are looking beyond the sometimes negative commentary about Japan’s economic prospects.
The kinds of opportunities that we are worth looking at in Japan will follow the trajectory of countries like the US and the UK. Think of Japan as on a time lag with certain changes to everyday life. For example, in the UK and many other countries, cashless transactions are extremely common. From using an Oyster card on the tube to contactless payment in a shop, everyday actions are usually cashless for many people.
In Japan, however, 80% of daily transactions are still made in cash. It’s not uncommon to find restaurants and shops that only accept cash still. COVID-19 exposed just how behind Japan is. As cashless payments and online transactions became necessary rather than optional, Japan had to play catch up. And Japan will catch up with the rest of the world in these areas.
E-commerce and cashless transactions are major growth areas in Japan
It’s similar with e-commerce -only around 10% of transactions are made online in Japan. This is obviously extremely low when we compare the rates of online e-commerce in the UK, the US and other Asian countries too, such as Korea and China. Last year’s events sped up the changes that were slowly emerging in Japan in these areas, and we can now see very strong growth rates for companies expanding or implementing an online presence – sometimes for the first time.
Other areas to look out for in terms of investment include enterprise software and companies that are moving services online. The pandemic showed that a significant number of corporate workers in Japan couldn’t work from home as they didn’t have the online connectivity available. Even people who worked for the likes of the Bank of Japan and major railway companies didn’t necessarily have the ability to work remotely. This shows a clear and urgent need for long-term investment in online infrastructure.
So, while changes have begun, there is still a long way to go. Initiatives such as the new digital ministry created by the Government to ensure that the 80,000 processes that used to need a physical stamp to be approved, no longer do. This is a major change, and while it is much later than other countries, having this kind of official Government push to go online will ramp up innovation and technology.
Infrastructure across the board needs updating and modernising
Many of the supply chain issues faced by Japan due to the pandemic can be put down to its old-fashioned offline infrastructure. For example, a vast number of restaurants in Japan order supplies by fax. Finally, this is being automated and shifted online, largely because of the pandemic.
When we consider that at the beginning of the pandemic in Japan (so around March 2020), crucial PCR data was sent to the relevant ministry via fax so that someone could manually put them into a spreadsheet. This is how far behind Japan was, and how much now needs to be done to bring it up to date with the rest of the world.
Automation is another growth area for investors, with Japan leading the world in some areas. For example, Japanese company Keyence is the world leader in sensors and has an operating margin of more than 50%. Automation is taking place across all kinds of industries in Japan, ranging from food to pharmaceuticals.
With the commitment made by Prime Minister Suga in 2020 that Japan will reach net carbon zero by 2050, there is an enormous amount of investment needed. There is such a long way to go, given that renewables are very much in the minority in Japan. Coal is still the number one fuel, which is obviously unsustainable. We will see a lot of investment into renewables. This is another long-term growth area – Japan needs to figure out how to solve the problem of energy sufficiency in a new and innovative way.
How is the Olympics 2020 debate impacting investors?
The main topic of media coverage about Japan right now is the new wave of COVID-19 and whether the 2020 Olympics will go ahead as planned in July 2021. With less than six weeks to go, this is a question that still can’t be answered.
The Japanese Government and International Olympic Committee (IOC) currently insist it will be going ahead, but there is a big public backlash against it. Investment wise, it doesn’t hugely matter. If the Olympics do continue, overseas visitors are precluded anyway, and all of the major investment into the games has already taken place.
Overall, the biggest and most significant change affecting Japanese equities is the fundamental improvements within shareholder culture. There are many fantastic investment opportunities in Japan for both domestic and overseas investors. Newer companies are springing up that challenge the traditional conglomerates that are slow to change and held back by out-of-date traditions.
New companies are more flexible, more innovative and tend to operate in a simpler way. Unencumbered by the legacy of the past, they’re easier to work with for investors and offer exciting investment opportunities.
Title: Corporate governance changes in Japan are impacting investors in a positive way
Investor interest in Japanese equity is growing, but here’s why it’s now time to shift from short-term thinking to long-term projections.
The changes we’ve seen in corporate governance is changing the game for investors looking to be involved with the companies they fund. In turn, this is impacting the stock market and opening up opportunities.
Japanese corporate governance is changing significantly
Anyone who has been involved in investing in Japanese equities for longer than a decade will be surprised by the changes regarding corporate governance.
These changes began back in 2014 when Prime Minister Abe launched the new Stewardship Code and corporate governance code., And since then, these changes have ramped up considerably.
More than half of all Japanese companies have a strong balance sheet with net cash, compared with only 15% for European and US companies. Furthermore, the number of outside directors being welcomed into Japanese companies is constantly on the rise.
Companies are also embracing the idea of having activist investors on their boards to assist them in moving forward more quickly. This simply wouldn’t have been possible even ten years ago. We’re also seeing more companies adopting ESG tents as a routine. All of these changes are underway, but it’s also worth noting that we are in the early stages of a long-term revolution in this area.
The external view of Japan is also undergoing change
People’s view of Japan is also slowly changing. The traditional idea of Japan propagated in mainstream media and movies conjures a picture of high-tech, fast moving Tokyo. Packed with technology and people, these images show Japan as something that it isn’t.
While, of course, there are areas like that in Japan, the majority of the country is lagging behind technological innovations already ubiquitous in other developed countries. For example, the shift towards a cashless society is well underway for many countries, with contactless payments totally run of the mill. But in Japan, around 80% of all day-to-day transactions are still made in cash.
This seems odd for a country that led the world in the 1980s in consumer electronics. But this wasn’t enough to future-proof a country steeped in strict traditional codes and business practices that didn’t allow for flexibility and innovation.
Japan has more than 4,000 listed companies and yet there is little mainstream global media coverage of these companies and what they can offer investors. This means there are massive opportunities for investors savvy enough to look beyond the headlines and strategise.
Japan is behind other countries in terms of technological advancement
Handily, we can also look at countries like the US and the UK to see the trajectory Japan is already on. We have blueprints for how technological innovations become mainstream. It’s just that Japan is slower than the rest. The pandemic showed Japanese companies just how out of date they are in terms of their online presence, and it has acted as leverage to get this moving. But Japan will catch up with the rest of the world in terms of digitisation and e-commerce. And for those who invest now, the rewards could be massive.
This is why digitisation, fintech and e-commerce offer such enormous opportunities for overseas investors. Currently, just 10% of transactions are made online in Japan, far lower than in the UK, Europe and much of the rest of the world. Changes that were only just underway before COVID-19 have been sped up in Japan as the country collectively clamoured for seamless online services when the infrastructure wasn’t there.
Similarly, there are investment opportunities in enterprise software developers and other companies that are shifting these services online. Even remote working accessibility was shown to be lacking during the first phases of the pandemic. All of this must now be improved and completely redeveloped.
COVID-19 has sped up the rate of change for Japanese companies
Offline, old-fashioned ways of doing business caught Japan out during the pandemic. For example, a large number of restaurants routinely order stock by fax. This is now being automated and moved online, and these changes are being sped up due to the pandemic.
Even crucial data about infection rates was sent to the Government by fax and then manually input onto a spreadsheet. This is an excellent example of the archaic systems that have been holding Japan back in so many ways. When Japan catches up with other leading countries, it will be in a positive position to consolidate its place as the third largest economy and build on this.
Automation and renewables are other major growth areas in Japan. While the Government has committed the country to net zero emissions by 2050, there is an enormous amount of work that must be done to ensure Japan is anywhere near this target by then. Currently, coal remains the biggest energy source and major technological innovation is necessary to come up with a solution.
These are long-term investment areas, and as changes continue to be made in terms of corporate governance, flexibility of businesses and through technological innovation, even more investment opportunities will arise. Newer companies are starting that offer the kinds of flexibility and open culture that will challenge the traditional Japanese conglomerates that are still clinging to the old ways.