The Covid-19 crisis has shone a light on business practices and conduct. It has exposed companies living on the edge; while those companies that have embedded good governance in the form of strong financial stewardship, sound employment practices and effective supply chain management have been able to sustain profitability and, most importantly, recover quicker.
The Aberdeen Japan Investment Trust focuses on quality companies, but an important part of our assessment of quality is to look at companies with strong environmental, social and governance (ESG) characteristics. Throughout the crisis, we have seen companies with high ESG scores prove more resilient than those with lower scores.
But what does this look like in practice? Nippon Paint has been a long-standing holding for the Trust. It makes paints and coatings and is currently the market leader in its area in China. The group has always taken employee well-being seriously and has worked hard during the crisis to protect employees and their families from the impact of Covid-19, putting employee safety top of its priorities. That means adopting teleworking, staggering commuting for employees and offering flexible work hours, while also ensuring social distancing, wearing masks, washing hands and sterilising.
Japan is facing significant labor shortages. Before the Covid-19 outbreak, there were 1.5 vacancies for every job applicant. It is clear that in a war for talent those companies that build a reputation for treating staff well are in a strong position. That extends beyond pay to working conditions and pastoral measures. During times of difficulty, being able to hire the best is vital for business resilience. We have seen this at Nippon Paint. It has been able to recover quickly as demand has recovered across China.
Another mark of quality and good governance is effective supply chain management. The crisis has put real pressure on supply chains. In the worst cases, companies have found themselves unable to obtain key components. Those companies that have built in good contingency planning have fared far better.
For example, Elecom makes peripheral electronics products such as keyboards, smartphone accessories and cables. It has always had good supply chain management and has reaped the benefits during this crisis. It has always kept in touch with multiple suppliers and during the crisis they have been able to source products flexibly. This means they have been able to keep up with burgeoning demand for their products as more people have stocked up to work at home.
We invest for the long-term and it is reassuring for us to know that a management team is able to adjust to unexpected events. Companies in Japan have been through difficult times before – from natural disasters to deflation. Management teams cannot predict individual crises, but they need to be able to adapt to changing circumstances and adjust to unexpected events.
Resilient, high quality companies generally have strong balance sheets. Low debt levels give companies optionality. They won’t be rolling over debt in the middle of a crisis; they can obtain financing if necessary and have the trust of the banks. They can make the right investments at the right time. This can be important in recovering well from a crisis.
These strong balance sheets allow companies to continue issuing their dividends, buying back shares and delivering for shareholders. An example in the Trust’s portfolio would be Okinawa Cellular Telephone, a mobile carrier based on Okinawa Island. It has enacted a share buyback programme and raised its dividend payout ratio even in the face of this crisis.
Okinawa Cellular also highlights another important attribute for companies and a key criteria for us as investors: a willingness to listen. We had been engaging with the company for a long time as it had excess cash holdings on its balance sheet, lowering capital efficiency. We had urged it to return some of that cash to shareholders. In its dividend and share buyback programme, the management team showed it was listening.
When engaging with companies, we act as investors not activists. We consider ourselves long-term providers of capital to individual companies and want to ensure companies are run to ensure long-term success. ESG considerations don’t stop at the point of investment, particularly in this environment. ESG is not just about reducing business risk, it is about running a business better.
We see signs of improvement in governance across the Japanese markets, with rising numbers of independent directors, but it is coming from a low base. If we can encourage companies to engage in a discussion on governance, it can help reduce risk but also ensure that the business is resilient and can still aim to deliver returns, in this crisis and beyond.
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.
• The Company may charge expenses to capital which may erode the capital value of the investment.
• Derivatives may be used, subject to restrictions set out for the Company, in order to manage risk and generate income. The market in derivatives can be volatile and there is a higher than average risk of loss.
• 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.
• 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.