23 June 2015

Konnichiwa. Remember Japan?

While all eyes are gazed on Greece at the moment – and quite understandably so, the focus of investors may be better directed at the resurgent Japanese equity market.

Yet despite impressive market returns, the progress remains all too easily dismissed. After two decades of false hope and broken promises many investors have come to treat Japanese equities with much scepticism.

Nevertheless, the progress is clearly evident if you’re prepared to take a closer look.

“Something A.B.E economics. Anyone? Anyone?”

With ongoing support from the Bank of Japan (BoJ), the Japanese economy has been undergoing a slow recovery. While much work remains to be done, the first two arrows of Abenomics appear to be having the desired effect.

However, it’s the spate of largely unheralded reforms that appeal most. These critical reforms are bringing shareholder interests in from the cold and have the potential to deliver investors with attractive returns as companies focus on improving their capital efficiency.

This has already resulted in a number of positive developments. For starters, Japanese companies are turning out impressive profits. The past earnings season was strong and beat upwardly revised estimates for the tenth straight quarter. No doubt a renewed focus on improving return on equity has helped and investors have been rewarded through share buy backs and higher dividends.

The road to reform

The Japanese government announced the Japan Revitalisation Strategy back in June 2013 and momentum to improve shareholder returns has been gathering pace ever since. We’ve seen significant changes such as asset allocation shifts in the dominant Government Pension Investment Fund (GPIF), the launch of the JSX-Nikkei 400 index (a “prestige” index of “higher quality companies”), voting guidelines against directors who fail to reach return on equity hurdles, and the recently adapted Corporate Governance Code.

The appointment of Independent Directors, targeting of higher shareholder profitability and improved investor transparency are all components designed to encourage Japanese corporates to lift their performance, especially if they want inclusion into the JSX-Nikkei 400.

The response by Fanuc, the giant robotics manufacturer best brings these influences to light. Having ignored investor relations over its entire existence, the announcement of a new investor relations department and the promise to return more cash to shareholders came as a (very) pleasant surprise.

Bank on more returns

Japanese stocks are still attractively valued and many companies continue to sit on large amounts of cash. And while exporters have done well off the back of a weaker Yen, a focus on domestic asset plays offers sound opportunities.

One area of interest is Japanese banks. Take a look at the chart below which shows the performance of the Commonwealth Bank of Australia (CBA) versus Japanese giant Mitsubishi UFJ Financial Group (MUFG) over the past three years[1].

The bank debate continues – Three year performance of CBA and MUFG
Returns for Commonwealth Bank in Australian dollars, MUFG in Japanese yen.

Despite the strong performance of Mitsubishi, it (and its peers) still trades at reasonable valuations (refer to table below). While our majors face increasing headwinds, Japanese banks continue to offer potential upside from the divestment of cross shareholdings and possible loan growth.

  Commonwealth Bank Mitsubshi UFJ Financial Group
P/E 15.7 12.3
P/B 2.78 0.82
Div Yield (%) 4.8 2.0
ROE (%) 18.4 7.4
1 Year return (%) 4.3 60.8
3 Years return (% p.a.) 19.9 39.4

As at 31 May 2015. Returns are in local currency and based on share price only. They do not include dividends.
Source: Bloomberg.

Meaningful reform is underway in Japan and the local sharemarket is responding. An exposure to Japan provides both diversification benefits and the prospect of strong returns. Instead of disappointment investors may soon be saying “domo arigato”.

Mitsubshi UFJ Financial Group and Fanuc are both holdings in the Zurich Investments Global Thematic Share Fund.


[1] Returns for Commonwealth Bank in Australian dollars, MUFG in Japanese yen.

Important information: The content of this publication are the opinions of the writer and is intended as general information only which does not take into account the personal investment objectives, financial situation or needs of any person. It is dated June 2015, is given in good faith and is derived from sources believed to be accurate as at this date, which may be subject to change. It should not be considered to be a comprehensive statement on any matter and should not be relied on as such. Neither Zurich Australia Limited ABN 92 000 010 195 AFSL 232510, nor Zurich Investment Management Limited ABN 56 063 278 400 AFSL 232511 of 5 Blue Street North Sydney NSW 2060, nor any of its related entities, employees or directors (Zurich) give any warranty of reliability or accuracy nor accept any responsibility arising in any way including by reason of negligence for errors and omissions. Zurich recommends investors seek advice from appropriately qualified financial advisers. Zurich and its related entities receive remuneration such as fees, charges and premiums for the financial products which they issue. Details of these payments can be found in the relevant fund Product Disclosure Statement. No part of this document may be reproduced without prior written permission from Zurich. PNOE-010248-2015
Past performance is not reliable indicator of future performance.

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