Latest manager commentary
For December 2020
- Japanese equities sustained their rally into December, as positive trial results for COVID-19 vaccines fostered optimism that a global economic recovery could soon be underway. Investors were further encouraged by a series of modest, but positive, announcements regarding Japan’s governance and stewardship codes. These positives shook off concerns of rising COVID-19 infections, and a sharp decline in Prime Minister Yoshihide Suga’s approval rating, as his administration struggled to respond to the pandemic. The market’s enthusiasm was particularly evident in the primary market, where we saw the number of initial public offerings rise to 26 listings, a substantial increase from prior months. And despite demanding valuations, these stocks, which are largely digital and asset-light businesses, were strongly sought after by investors in the secondary market and, on the whole, appreciated by nearly 90% from their IPO price in a matter of weeks.
- The optimism in the markets capped a year in which Japan equities joined the global “everything rally”. TOPIX Index recovered from earlier losses to end the year with gains of 4.8%, rising 46% from the bottom in mid March. Similar to markets elsewhere, we saw a bifurcation in the Japanese market, with new economy companies superseding that of the old economy, the virtual world gaining at the expense of the physical world; stock valuations of the former basket were increasingly extended, whilst those in the latter languished. As the year progressed, it became evident that early prognosis of the pandemic’s impact was much harsher than reality, with many Japanese corporates reaffirming our view that they would yet again be able to lower expenses when faced with harsh business conditions, and in some cases, swiftly pivot their businesses to capture rising opportunities in the new normal.
- Looking ahead, favorable fundamentals and a recovery in global trade should provide some tailwind for Japan equities, while improving governance should drive greater shareholder value. Meanwhile, valuation disparities have widened; the impact of the evolving geopolitical climate presents a risk; and COVID-19 infections have continued to rise across the globe. In Japan, the Suga administration will continue to backstop the economy, as stakes are high for the prime minister to stabilize the economy ahead of a likely snap election before October. And with inflation again receding, Bank of Japan’s Governor Haruhiko Kuroda remains firm on maintaining its 2% inflation target, and it expects to announce a review of its stimulus measures in March.
- In spite of the pandemic, Japan Inc.’s corporate governance continued to evolve. Companies improved on disclosure, investor engagement and board structures; the addition of more independent board members has resulted in improved diversity and more relevant experience at corporate boards, and nomination and remuneration committees are also increasingly commonplace. Empirically, these changes, along with a greater awareness by internal management teams to protect and improve shareholder value, played a part in the rising frequency of share buybacks and more shareholder friendly capital management policies. The defining moment in the last year was the rare decision by the board of home-improvement retailer Shimachu to recommend Nitori Holdings’ higher but unsolicited bid, despite already accepting a lower offer by fellow retailer DCM Holdings. Such hostile takeovers have been difficult to execute, a result of weak governance in corporate boardrooms, and while it is common elsewhere for corporate boards to seek the highest price when a company is put up for sale, this has often not been the case in Japan. But a gradual change in mindsets, alongside a moderate effort in unwinding of cross-shareholdings, could eventually result in a tipping point.
Similarly, we have observed these positive trends in corporate governance within our portfolios, as evidenced by the number of engagement wins across our invested holdings this year. These are borne out of conversations and ideas seeded over time, and we do not expect this momentum in our work to slow. Ongoing discussions include:
- A major auto company to improve disclosure of quality management systems, to highlight efforts on quality and safety standards. We believe the company is selling itself short by not providing detail about its quality assurance.
- A mid sized real estate company to consider a more drastic restructuring to curtail or carve out businesses that generate lower returns.
- A mid sized capital goods company to create a framework for improving returns across its businesses.
- A smaller real estate company to reject the potential renewal of takeover defense measures and to implement a majority external board and nomination and remuneration committee.
All cap corporate commentary
- Furniture retailer Nitori Holdings reported 3rd quarter results that were in-line with expectations. More importantly, we were encouraged that management struck a positive tone for next year’s prospects, as it looks to generate meaningful cost cuts by streamlining its operations, while sustaining strong growth in its online and brick-and-mortar stores. The company will also embark on the consolidation and restructuring of its acquired stores from Shimachu, which could lead to improved profitability in the medium term.
- HR solutions provider Recruit Holdings conducted a global placement of 5% of outstanding shares, as several advertising agencies and broadcasting firms cut their stake. We commend Recruit’s management on practicing sensible capital management, as it also announced a buyback for 1.2% of shares to offset the negative impact on existing shareholders from the placement. We participated in the deal, given the compelling discount on the offering and our favourable assessment of the company.
- In response to a business improvement order from the FSA regarding a one-day outage of the Tokyo Stock Exchange in October, Japan Exchange Group announced its decision to accept the resignation of TSE president, and also announced that JPX’s president would take a 50% cut in salary for four month and would take on the dual role of leading the exchange and holding company.
- Digital marketing solution provider ValueCommerce announced an upward revision to its profit guidance, as the company benefits from increased e-commerce transactions on Yahoo! Japan’s platform.
During the month, we exited our position in pharmaceutical company Shionogi in light of better opportunities elsewhere. The company has a strong infectious disease franchise focused on HIV treatment, but we have rising concerns about competition for its therapies and the company's ability to build on its future pipeline to overcome an upcoming patent cliff.
During the month, we initiated positions, via IPO participation, in Plaid and WealthNavi. Plaid is a provider of customer experience SaaS; its KARTE brand of data analytics solutions collect and analyze online user activity on a real-time basis. Given its timely analysis, website and app operators can visualize and interact with customers on a more personalize and effective basis to improve conversion rates. While IPO valuations were full, Plaid’s sizable addressable market and unique value proposition, which warranted an investment from Google prior to its IPO, translated into a robust growth outlook that justifies its price. Similarly, we think fintech firm WealthNavi’s roboadvisory business has sizable growth prospects, as it targets a growing segment of relatively young consumers who are tech-savy and are struggling to invest excess savings in a ultra-low interest rate environment. We look for the company’s first mover advantage, operational know-how and the ease of use for its app to drive strong growth. Again, IPO valuations were demanding, but justifiable given its large addressable market and strong positioning of its business model.