Finding value in Japan

Warren Buffett’s decision to up his investment in several Japanese companies in 2023 has brought the country’s stock market back into the spotlight. Although Buffet’s investments were made to seem novel by the press, the reality is he – and many other investors – have been finding the country an increasingly attractive place to invest over the past few years.

Looking at the past decade, flows into open-ended funds investing in Japan started to pick up after former prime minister Shinzo Abe came to power in 2013. Although the pandemic led to some outflows, these have turned positive again in the last 12 months, coinciding with a period of positive performance for Japan.

That reflects growing optimism about a country that has long had a tainted reputation among investors, mainly due to the ‘lost decade’ in the 1990s. Reforms that are pushing companies to improve returns and pay out dividends to shareholders have helped change this and also appear to have made some investors realise just how attractive the opportunities in Japan are.

In addition, after more than two decades of deflationary pressure, the emergence of “positive” inflation, led by wage growth, is immensely encouraging. Indeed, the implications of this positive inflation should not be under-estimated for corporate Japan.

Schroder Japan Trust (SJG) offers investors a unique way to take advantage of these trends. The trust is managed by Masaki Taketsume and has an extensive, on the ground analyst team with a wealth of experience.

Masaki takes a value-driven approach to the Japanese stock market, looking for companies whose share prices aren’t reflective of their true worth. It’s an approach that is arguably ideally suited for Japan today.

That’s because, although the Topix Index hit all-time highs in 2023, there are still many companies listed in Japan trading below book value. It’s a similar story with the MSCI Japan Index, which is trading below comparable US, emerging market, Europe, and Asia ex-Japan indices on a cyclically adjusted P/E basis.

Mitsui Chemicals provides one example of these dynamics, with the company trading at a price-to-book ratio of 0.86 as at 12/10/2023. Masaki invested in the firm because they believe the company’s plans to improve profitability and mitigate some of the risks that come with being in a cyclical sector are already bearing fruit in the form of improved earnings. However, the market is yet to recognise this – hence the low valuation.

The company is also a good example of another key attraction that SJG offers, namely the ability to take positions in small and mid-cap Japanese companies. Partly that’s due to the trust’s size and closed-ended structure, but it’s also a result of the team’s local knowledge and the on the ground presence. Many smaller firms in Japan have little to no analyst coverage locally, let alone internationally, making it easier for SJG to find an informational edge.

Aside from Mitsui Chemicals, other SJG holdings provide good examples of the exciting opportunities that exist here. For instance, the trust currently has holdings in specialised electronics manufacturer Ibiden and Disco Corporation, a company that makes equipment used in the semiconductor industry. Both have performed well on the back of the AI boom.

SJG has had a strong 18 months, reflecting the bounce back Japan has had post-Covid, as well as renewed interest in its stock market. This built upon an already strong track record, with the trust delivering outperformance in the 1, 3, 5 and 10 year periods up to the end of September 2023.

There are no guarantees that will continue moving forward. Nonetheless, the trust may benefit if Japanese reforms continue and we see further inflows into the market from both foreign and domestic investors.

Our analysts say: “Masaki’s bottom-up approach seems to us to be an attractive way to invest in the country. Macro trends, largely in rates, have driven global equities in recent years, leading to extreme rotations in the relative performance of growth and value. We would not expect this to continue [with] rates and inflation at higher levels, and any declines likely to be slower and complicated by weaker economic environments. As such, a stock-picking approach with a strong quality focus seems appropriate to us.”

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