Written by Richard Aston, manager of the Chikara Japan Income & Growth Fund and the CC Japan Income & Growth Trust PLC
Direct foreign investment into Japan increased for the second year in a row in 2022, hitting a record US$32.5 billion. It looks like this direction of travel is set to continue, too, with Nomura Securities forecasting a further US$70 billion of inflows from here.
The boost can likely be attributed at least in part to robust equity market returns of late.
The Nikkei 225 posted its largest first-half gains in a decade over the first six months of 2023, surging 27%. And with the country’s delayed post-COVID reopening meaning inbound tourism and domestic consumption are still catching up, we believe this outperformance can continue.
That being said, we feel the increasing foreign interest is also being driven by Japan’s steady trend towards corporate governance reform. Indeed, after side-lining the nation’s equities for so long, more and more professional income investors appear to be recognising the long-term value this stands to deliver.
It’s not too late to join them. With the yen continuing to trade at a considerable low against the dollar, it can be argued that an excellent entry point is continuing to present itself.
Japanese companies have long faced criticism over corporate governance practices perceived to favour management over shareholders. This all began to change, however, with the introduction of Abenomics in 2012.
Corporate governance and stewardship codes were initiated to promote the fairer treatment of shareholders in various ways.
This included emphasising shareholder returns by encouraging companies to use their accumulated cash reserves for dividends and share buybacks. But it also included ensuring investors were actually acknowledged by management through the promotion of shareholder engagement, board independence, and transparency.
Such efforts continue to this day. Most notably with the ongoing reform of the Tokyo Stock Exchange into three segments with strict listing criteria designed to enhance corporate value and return on equity.
And it has become increasingly clear to us – along with others – that they are having the desired effect on listed companies.
For one thing, the amount of money being put back into the hands of shareholders has been increasingly consistently in Japan. In the short period since the pandemic alone, companies have increased dividends by approximately 40% while buybacks have almost doubled compared to pre-Covid levels.
Likewise, we have seen many high-profile instances of Japanese companies bucking the trend and increasing their accountability to shareholders.
This includes the unwinding of cross-shareholdings – the practice where peer companies hold ownership stake in one another.
It also includes various reports of incidents where boards are adopting changes and new practices in response to the demands of shareholders. On the more aggressive side of things, a Reuters monthly poll from June 2023 even suggested nearly 70% of Japanese firms expect an increase in proposals from activist investors.
As these corporate governance standards continue to improve – and there is no suggestion they won’t – so too does the attractiveness of Japanese firms to investors. Aside from improving the efficiency of their capital allocation, it should reduce their overall risk through better oversight and more responsible management practices.
This is an excellent foundation for all market conditions.
But right now, it is also setting many stocks up to benefit as much as possible from other long-term trends emerging in the Japanese market.
One of these is the growing effort to address the nation’s aging population.
This has long cast a shadow over Japan’s economy as it stands to reduce the overall size of its workforce, potentially limiting growth and productivity; but through directives such as encouraging immigration and announcing plans to invest more in children and families the country is now tackling this head on.
Many companies stand to benefit from the positive impacts this should have on the Japanese economy. However, those with the highest corporate governance standards should be the best performers.
Another trend is a forecast loosening of monetary policy.
It should be noted that this is rooted mainly in the Bank of Japan’s recent drive to introduce “greater flexibility”. But the general consensus now among those on the ground is that a move away from negative interest rates is no longer a case of if but when.
Should this happen, then many leading banking stocks stand to become highly attractive investments. Not just because of the positive impact it should have on their profit margins, but also because of the larger share investors stand to receive in the wake of a long period of dividend hikes.
All told, the notable recent increase in direct foreign investment into Japan is not surprising to us.
Yes, the market is enjoying a period of strong performance in the inevitable economic swell of a delayed post-Covid re-opening.
More fundamentally, though, the nation’s proven dedication to improving its treatment of shareholders primes its growing pool of quality income stocks for a period of intense outperformance in the face of other positive long-term trends.
With the current weakness of the yen offering, in our opinion, an excellent opportunity to get in cheap, right now seems like the opportune moment to catalyse.