Despite being the third largest economy in the world, Japanese equities are often overlooked by overseas investors. However, such oversight cannot be levelled at M&G’s Asia Pacific Equity Team who are extremely bullish about the prospects. In this interview, the Team’s Co-Head, Carl Vine, tells IFA Magazine exactly how and why M&G has been capitalising on the uniquely compelling investment opportunity that Japan equities now present, whilst others may be looking right past it.
Vine’s team places an emphasis on stock picking. Their company specific approach hunts for debates or market blind spots that are associated with large gaps between price and intrinsic value. This, they believe, allows them to steer clear of the style-driven strategies offered by some of their peers.
In this Q&A, Vine discusses why he believes that undervaluation and corporate reform make Japan such an attractive asset class, how active stock picking allows his team to extract Alpha from the market, and how the attitudes of Japanese businesses have allowed the country to navigate a global inflationary environment with fewer negative impacts than other global competitors.
IFA Magazine: Why do you believe that Japan is a good asset class to invest in right now?
Carl Vine: “We believe that Japanese equities present an extremely compelling long-term investment opportunity. That’s the big picture here. Firstly, there is an extremely powerful structural earnings story unfolding in Japan. We believe this story has legs for many years to come. Secondly, the price that investors are paying for that structural growth, in our opinion, is extremely modest.
“In the past, Japan has been seen as something of a value market, but for us, when we look at it today with fresh eyes, it’s more of a GARP – or growth at a reasonable price – market. It is worth reflecting on the fact that Japanese earnings have in fact compounded at close to a 10% annualised rate for the last decade. This is comparable with the mighty S&P 500. It’s been a pretty remarkable decade for earnings delivery, even despite a pretty mediocre macro environment in Japan. That growth has come from self-help; it’s not been top line driven. It’s come from intentional efforts by Japanese companies to become better corporate athletes; more efficient, and more competitive.
“When we look at the next ten years, the outlook for earnings is most likely even better than the last ten, in our opinion. That’s not based on some macro or GDP forecast. It really comes down to this ongoing trend of corporate self-improvement and corporate self-help we see in Japanese businesses. The changes of the last decade in the corporate landscape have been extremely significant and in fact, in line, with what former Prime Minister Abe imagined ten years ago. The Companies Act has been overhauled, we’ve got a stewardship code, we’ve got a governance code, we have new proxy-voting guidelines, new M&A rules, and a new tax code. These are all major changes to the environment within which Japanese companies operate and they’re using these new incentives and toolkits to improve and optimise.
“Coming back to the question of why Japan is interesting right now, that answer really does centre on this point about structural earnings growth. We believe there is a lot of low-hanging fruit still left in the corporate sector. Japanese margins are still about 7%, less than half what they are in the US and balance sheets have excess assets, in the form of working capital, real estate, net cash, and so on. Japan’s industry structure is over-fragmented. These are all sources of upside, irrespective of the macro environment. Unlike the past, today we now have the incentives, behaviours and institutional support for this low hanging fruit to be harvested.
“Prospective returns are always difficult to forecast. However, if your earnings are growing at 10% compound, your starting dividend yield is just under 3% and the stock market is buying back two and a half percent of itself per year, you very easily get to a ten-year prospective compound annual return in the mid-teens and that’s before you get any uplift from valuation and before we get any benefit from inflation. Mid-teen returns driven by structural profit growth, that is somewhat insulated from macro variables feels exciting to us. The fact that these earnings are so modestly valued is the icing on the cake, delivering a compelling risk reward in Japanese equities.”
IFA Magazine: How do you extract Alpha from investing in the Japanese market?
Carl Vine: “There’s a universe of companies that we’ve been following for a couple of decades or more. For those companies, which we diligently track, we compare the price of ownership, which we see in share prices every day, with the risk of ownership as we assess it through our fundamental analysis.
“Then we look for dislocations between the price and risk, where those dislocations are associated with a specific debate or controversy that we have earned the right to a differentiated perspective about. We’re looking for very company-specific investment opportunities where the market is overly complacent or overly optimistic about a certain aspect of a company’s business. That’s where we get interested. Valuation alone is not enough. We want to know why something is mispriced, why that mispricing represents an exploitable opportunity and why we deserve to earn excess returns in that specific situation.
“We are entirely focused on building a portfolio of specific, esoteric and non-correlated mis-pricings. That’s the stock picking programme that we bring to bear in Japan. One of the amazing things about the Japanese market is that, despite it being the third biggest economy in the world, it’s pretty much overlooked by overseas investors.
“The active management community is surprisingly sparse when it comes to the equity asset class in Japan. For a team like ours which has been consistently honing its stock-picking skills for 25 years, it feels as though we’re in the right place at the right time. We have a bizarre situation where there is enormous amounts of change under way in Japan with very few qualified people actually observing it. For stock pickers like us, this makes Japan a really interesting market in terms of alpha generation.
“At the best of times, markets are poor at pricing change. In Japan we have a situation where there is more change than at any point I can remember and overseas interest at a major lull. That makes for a pretty rich environment for stock pickers like us.”
IFA Magazine: How are Japanese companies dealing with inflation?
Carl Vine: “It’s a very interesting discussion and a timely question. Inflation is evidently a hot topic globally, but I’m really interested in what’s happening in Japan.
“There is this global context of raw material cost-push inflation but there’s a bigger context here for Japan. Japanese companies haven’t been raising prices for their products for two or three decades. If I cast my mind back a year, we were asking ourselves what Japanese companies would do in this situation. The answer is that they are increasingly passing along input price pressure in order to defend their margins. This is new behaviour, very different from the past. We should not underestimate how important a behavioural shift this is for the equity asset class in Japan. There’s been a total shift in mindset around product pricing and inflation. Increasingly, companies are using price as a critical part of their company toolkit in terms of growing or defending margins.
“The other thing we are seeing in Japan, in an attempt to combat input price inflation, is an ongoing ability to find, year after year, new ways to cut costs. This has resulted in impressive earnings resilience in Japan in these tumultuous past few years. Generally speaking, I’d estimate that around half of that resiliency comes from this new-found willingness to raise product prices and half from internally generated productivity gains.
“If we think back to 2011 and the devastating earthquake and tsunami which hit Japan. This was a dry run of what to do when the economy stops dead in its tracks, like it did during COVID. Of course, COVID was global, the problem was much bigger. In Japan’s case, I wonder if part of the relative earnings resiliency we have seen dates back to contingency playbooks that evolved following the great eastern earthquake.
“They built and developed a resiliency through that experience that has put them in tremendous stead during this rolling series of COVID-linked supply disruptions. I’ve been really impressed with how Japanese companies are dealing with disruption and inflationary pressure. In fact, rather than the old view of Japan as a levered value play on global growth, we increasingly see it as an unlevered play on self-help.”
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The views expressed in this document should not be taken as a recommendation, advice or forecast.
About Carl Vine
Carl Vine joined M&G in 2019 as Co-Head of Asia Pacific Equity Team. Carl has 25 years of investment experience in Japan and is the lead manager for M&G’s Japanese Equities strategies. Prior to this, Carl co-founded Port Meadow Capital Management, a boutique Pan-Asian investment firm, in 2014.
He has previously worked as a Managing Director and Portfolio Manager for SAC Capital Advisors in Hong Kong and was the Asian-based member of their global investment committee. Before that, Carl was a Managing Director at UBS in Hong Kong, where he invested proprietary capital across Asia including Japan.
He began his career with Prudential Portfolio Managers in London, before relocating to Tokyo to open Prudential’s Japan office. Carl holds a Bachelor of Arts (Hons) in Politics, Philosophy & Economics from Oxford University.
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