Japan: where necessity is the mother of invention

Head of Investment Management at Aberdeen Japan Investment Trust PLC looks at the investment opportunities and the economic outlook in Japan


 

-Fertile ground for investing in world-class companies despite domestic economic challenges.

-Companies have expanded overseas to find growth and are geared into the consumption of Asia’s rising middle classes.

-Innovation powers global leadership in robotics and other automation technologie.

-We are encouraged by signs of progress as we engage company managements to improve returns

Japan is home to a plethora of world-class companies in spite of the harsh economic realities of recent years – making it fertile ground for the Aberdeen Japan Investment Trust PLC management team.

The nation’s ageing and shrinking population impedes policymakers in their efforts to effect economic growth. But the Trust has found companies that have survived and thrived in this environment by making themselves leaner, more efficient and more productive. The best among them are leading players in their industries and are global. They have transcended borders.

If necessity is the mother of invention, Japan is at an advantage. Streamlining and restructuring can drive profitability in addition to top-line growth. Local companies have also had to look overseas for growth to lessen dependence on the domestic economy. Those with industry-leading positions have pricing power. Those with global production lines benefit from risk diversification. It means Japanese companies can often be found operating in higher growth emerging markets.

The Trust’s portfolio includes a maker of baby bottles and products, which is geared into the rising middle classes in China and Southeast Asia. Just one million babies are born in Japan each year, while 15 million were born in China last year, which is the company’s major market.

More broadly, Japanese companies have proved adept at building good consumer products with strong brands that have resonance across Asia. They have established a reputation for high quality – which means their products can be priced at a premium.

The tough domestic backdrop has also inspired a bold approach to innovation. Japan leads the world in certain automation technologies. Some are borne out of the country’s car industry, including firms that manufacture quality-control sensors, which cut down on costs and defects. But it is in robotics where Japan leads the world. There is unrelenting demand in countries such as China, where manufacturing automation is key to saving on rising labour costs and improving product quality.

Health care is another critical area. Japan’s population is ageing – 38% of Japanese are expected to be aged 65 or over by 2065, making it the world’s leading “super-aged society”, as reported by Forbes. The social care bill is rising at a time when the working population is diminishing.

But again the best companies have not stood still. Among the Trust’s holdings are firms that consistently invest in research and development to maintain a competitive edge, in areas such as medical equipment. What at first appears a demographic headwind in fact becomes a tailwind supportive of growth.

In view of the above, Japanese companies do not necessarily reflect the weakness in the domestic economy. They are also cash-rich, enabling them to withstand difficult times. While this has led to lower return on equity for some companies, it is an area we continue to engage them on – and we are seeing encouraging signs of improvement.

We believe that a focus on investing for the long term, and corporate engagement, will help company managers to do the right thing – including paying out excess capital on their balance sheets.

The government is trying to do something similar, encouraging compliance with its governance and stewardship codes. Greater recognition of the importance of governance among Japanese corporates should lead to improvements in capital efficiency. Because of the low starting point, the scope for improvement is vast. As more companies embrace an increasingly shareholder-friendly stance, investors stand to get a better deal.

We are strong advocates that shareholder returns can be improved, and we are seeing more companies raise pay-out ratios and/or carry out buybacks. Share buybacks at Japanese companies reached record levels last year. While the market has welcomed this, we have been more cautious. Buybacks have almost become a reflex. They make little sense when valuations have risen. We prefer companies to be more strategic and consider raising pay-outs or offering special dividends.

We want to invest in and engage the more progressive companies that will safeguard the interests of all shareholders. When a company improves capital management and governance, it lowers our investment risk.

Good governance, company performance and sound capital management are closely linked, in our view. It’s why we will continue to engage managements and boards to improve returns. If we are confident that management will increase a company’s value over the long run, we have every reason to stay invested.

 

Important information

Aberdeen Standard Investments is a brand of the investment businesses of Aberdeen Asset Management and Standard Life Investments.

Risk factors you should consider prior to investing:

-The value of investments and the income from them can fall and investors may get back less than the amount invested.

-Past performance is not a guide to future results.

-Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.

-The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.

-The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.

-Movements in exchange rates will impact on both the level of income received and the capital value of your investment.

-There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.

-As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.

-The Company invests in emerging markets which tend to be more volatile than mature markets and the value of your investment could move sharply up or down.

-Specialist funds which invest in small markets or sectors of industry are likely to be more volatile than more diversified trusts.

-Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.

Other important information:

Issued by Aberdeen Asset Managers Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Registered Office: 10 Queen’s Terrace, Aberdeen AB10 1XL. Registered in Scotland No. 108419. An investment trust should be considered only as part of a balanced portfolio. Under no circumstances should this information be considered as an offer or solicitation to deal in investments.

Find out more at: http://www.aberdeenjapan.co.uk