Corporate balance sheets in Japan are “too strong”, according to JP Morgan Asset Management’s Nicholas Weindling, who points out almost three times as many companies in the Topix are net-cash compared with major indices in Europe and the US.
However, the manager of the JP Morgan Japanese IT said that while a culture of hoarding cash has hindered the performance of Japanese companies in the past, it puts them in a powerful position to cope with the challenges of the short and long term.
Economic growth across the globe is currently lacklustre, with the number of earnings downgrades steadily increasing. At first glance this problem looks particularly acute for Japan, with approximately 60 per cent of companies listed on the Topix classed as cyclical compared with about 30 per cent in Europe and a quarter in the US.
Yet, Weindling said there are two reasons why this is an over-simplistic reading of the situation. First, the Topix is outdated and not representative of the Japanese economy – like most developed markets, Japan is dominated by services rather than exporters. The second goes back to the culture of hoarding cash.
“It is important to remember, especially if we're going into some kind of slowdown, that Japanese companies are extremely strong in terms of their balance sheets,” the manager said.
“I mean, we'd certainly argue they are too strong. But in a downturn, this will be helpful. So, 56 per cent of companies in Japan are net-cash, dramatically higher than what you see in the rest of the world.”
Weindling said that as well as putting Japanese companies in a strong position should the global economy take a turn for the worse, this net cash position gives them plenty of options when it comes to improving value for shareholders. Corporate governance reforms in Japan have encouraged companies to return cash to investors, and the combined value of dividends and share buybacks broke records in every one of the four years to the end of 2017. The manager said this could be just the start of a multi-year trend.
“I'm not at all saying that Japanese corporate governance is good, I think that it’s got a long way to go,” he continued.
“But in some ways, that is the beauty of this as an investment theme for the market overall.
“Even recently, we started to see things in Japan that never happened before – we have started to see hostile takeovers for companies here, we have started to see companies aggressively merging with each other, we have started to see private equity being much more involved in this market.
“And the reason why those things can happen now is because it's much more pushing on an open door. Up until 2014, there wasn't a corporate governance code here, that was no stewardship code, Japanese companies were very reluctant to improve their balance sheets. But that's all started to change, thanks to [Shinzo] Abe's reforms.”
While things are improving at a corporate level, Japan still faces numerous challenges in terms of demographics, with an ageing and declining population. This has resulted in the tightest labour market in the world, with 100 applicants for every 160 jobs, while the average age of a Japanese rice farmer is 72.
Weindling, who is based in Japan, has seen this at an anecdotal level as well, with local fast-food noodle restaurants that claim to be open 24 hours a day shutting early due to a lack of staff.
However, again he said that Abe is taking action to help address this headwind, pointing to a chart he said he thought “he would never be able to show in his investment career”.
“It looks at female participation in Japan compared with the US,” he explained. “It is really striking.
“Whereas 20 years ago there was a massive gulf in terms of women in the workforce, that has reversed and particularly recently, you can see how the line has got much steeper.
“Or it's why when I walk into a convenience store like 7-Eleven, these days there are many non-Japanese staff in that store. The one next door to where I live is almost entirely staffed by people from India, which I know is not unusual when you live in the UK and so on, but in Japan it is still very new that we see foreigners working in these kinds of jobs.
“For me, it's probably one of the most visible changes I've seen during the 15 years I lived there, so you start to see foreigners working on construction sites, where the average Japanese construction worker is aged well over 50.”
Immigration is not the only way in which Japan is opening itself up to foreigners. In 2012, 8 million tourists came to Japan, but in 2018, this figure had jumped to 31 million. Weindling said there are numerous reasons to visit Japan, including skiing (“Japan has some of the best snow in the world”), food (“Tokyo has three times the number of Michelin Stars of Paris”) and history (“there are 23 UNESCO World Heritage Sites in Japan”). The real question, he said, was why more people didn’t visit before.
“The reason that Abe is responsible is because he relaxed visa restrictions for people from Asia,” the manager continued.
“And the reason why we think it's sustainable is because incomes are rising across Asia and Japan is relatively near.
“We think the middle class will want to do things like travel, which is the classic investment theme of experiences over things, which is one of the big areas that people look for.
“[So] from our point of view, Abenomics has been much more successful than we ever expected.”
Data from FE Analytics shows JP Morgan Japanese IT has made 162.11 per cent since Weindling took charge in November 2007, compared with 217.91 per cent from its IT Japan sector and 127.42 per cent from its Topix benchmark.
Performance of trust vs sector and index under manager tenure
Source: FE Analytics
It has ongoing charges of 0.67 per cent and is 15 per cent geared.
The trust is on a discount to net asset value (NAV) of 10.83 per cent, compared with 8.98 and 10.10 per cent from its one- and three-year averages.