Many fund managers claim that an active approach to investing is particularly important in the area where they are running money, yet often fail to back this up with a convincing argument why. However, Coupland Cardiff’s Richard Aston says that the reason for avoiding a passive approach to Japan is obvious – large areas of the market have no interest in making money for shareholders.
Aston runs the CC Japan Income & Growth Trust, which was launched in 2015 to take advantage of the growing appeal of Japan to income-seekers thanks to prime minister Shinzo Abe’s eponymous programme of structural reforms, Abenomics.
However, while some companies are helping Abe achieve his third aim of encouraging investment by placing a greater emphasis on dividend payments, Aston said there are entire sectors whose vital role in Abenomics is not compatible with delivering value for shareholders.
“Steel and shipping are the two best examples and we have talked about them many times,” he said.
“These are sectors whose role in society is not rewarding shareholders, not rewarding pensioners; it is maintaining Japan's independence and international security.
“Japan probably has way too many shipping companies, but it won't allow its course to be dominated by ships flying the Korean or Chinese flag.”
Aston added: “There are other companies and other sectors where their current role is not primarily shareholder returns, it is maintaining levels of employment.
“Large employers in Japan like Hitachi, NEC, Fujitsu and so on employ hundreds of thousands of people, that's their immediate goal in the long run.
“Things might change when they are much more efficient operations and Japan as an economy is much broader. But for the time being, maintaining that employment is, we believe, the priority.”
As a result, the manager tends to stay away from these areas although he said this does not mean these companies will never be useful holdings, nor that they cannot outperform.
For example, Aston said there are certain periods when the market decides, for whatever reason, it would be a good idea to buy a steel or a shipping company. However, the CC Japan Income & Growth manager said these periods of outperformance are becoming shorter and shorter.
“And that period of underperformance is something we can tolerate because those companies don't suit the strategy that we feel is appropriate for the long run,” he continued.
“If you actually look at the return profile for steel companies and shipping companies, it's very interesting. The leading companies in those sectors all cut their dividends to zero in the last few years. I mean it is a very clear indication that shareholders are not their priority, it is maintaining an industry that supports the Abenomics project.”
To show why this is so important in Japan, Aston pointed to the performance of the Topix after its peak in December 1989. While any UK investor unfortunate enough to enter the market at this point would still have been in negative territory more than 26 years later (Japanese investors would still be in the red), the manager said there were about 50 companies that had a higher share price when the market bottomed out in August 1992 than they did at its peak.
He pointed out one thing that all of these companies had in common was that they placed shareholders first.
Performance of index since launch
Source: FE Analytics
Aston added that Japan continues to feel the legacy of the early 1990s crash to this day; because an entire generation has only known an equity market that has fallen, and a property market that has gone the same way, people remain fearful of investing. Yet he pointed out they are taking this risk aversion to extreme, and damaging, levels.
“Their appetite for financial risk has been non-existent for years,” he added. “Despite all of the changes over the last 10 years, with the government promoting equity investment and even with the yields available in the equity market and in the REIT [real estate investment trust] market, more than ¥200trn in additional money has gone into the banking system at zero interest rates.
“And this is estimated to be only a percentage of their net wealth. A lot of it still goes into safety deposit boxes and under the mattress.
“This means individuals in Japan, even if they were just to buy a passive fund yielding 2.5 per cent, are foregoing ¥5trn yen of income because of this fear they have about capital loss.”
While Aston’s strategy is not dependent on the Japanese population breaking this mindset, he said that doing so could unlock an unprecedented tailwind for this market.
Some analysts claim that culturally, the Japanese are more cautious when it comes to spending than their British counterparts, meaning investors shouldn’t hold their breath. However, the manager said this ignores what has happened in the past.
“In the 1980s, people in Japan were happy to spend, to go out and speculate on the stock market,” Aston continued.
“So it did exist, that sort of entrepreneurialism and animal spirit. But unfortunately, Japan has experienced this 30-year deflationary environment [and] people just become accustomed to a certain manner of behaviour. It's that mindset that needs to change, which is where the bottleneck is.”
Aston said it is something of a ‘catch 22’ situation: one of the reasons people don't go out and spend is because there is no wage inflation, but companies say the reason they don't raise prices is because individuals in Japan are so cautious and will cross the street to buy something cheaper. This means they don't have the money to raise wages.
While there has been no sign yet of anyone being willing to break the cycle, Aston said this could simply be a generational problem, rather than a cultural one.
“The demographic profile is fairly open,” he added. “The elderly or ageing population will have a very different manner of spending in their current age group than they did 30 years ago when they were in their 30s or 40s.
“There's a demographic profile in this, hence there's a very important intergenerational transfer of wealth that has to be managed. I think if we do see any evidence of that mindset changing, we would get very excited about the prospects for sure.”
Data from FE Analytics shows CC Japan Income & Growth Trust has made 67.14 per cent since launch in November 2015, compared with gains of 58.74 per cent from the IT Japan sector and 53.24 per cent from the Topix index.
Performance of trust vs sector and index since launch
Source: FE Analytics
The trust has ongoing charges of 1.19 per cent, is yielding 2.53 per cent and is 21 per cent geared.
It is trading at a discount of 3.24 per cent to net asset value [NAV] compared with 0.21 per cent and a premium of 1.42 per cent from its one- and three-year averages.