Japanese company models more important than Abe’s success

For nearly a year now the Japanese stockmarket has been a centre of attention for global investors, especially since investors have come to understand that Shinzo Abe, the prime minister, has a much bigger ambition than just boosting exports by weakening the yen, but comprehensively modernising the Japanese society.

There have been some encouraging signs in the last few months such as increasing inflation which has finally come in above deflation level. GDP growth and consumer confidence have started to accelerate and unemployment rates to decline. This all means the Japanese economy seems to be slowly returning to positive nominal growth and mild inflation. As such, Abenomics has achieved its initial goal of ending price deflation and economic stagnation.

The key factor in the longer term, however, will be whether Mr Abe succeeds in overcoming the conservatism within his country. The call is for broad-based reforms in the areas of healthcare, energy, education, administration, taxation, the electoral system and immigration – a mammoth programme. But there have been plenty of companies playing a pioneering role in particular aspects of social reform.

The general environment is one where sclerotic corporate structures are the norm, the principle of seniority holds sway and the lack of foreign language skills alone makes companies unfit for international competition. Yet for some time certain companies have been making management appointments on the basis of ability rather than age, and holding meetings in English. Recruitment processes have been modernised, with considerable numbers of women in management positions. Among the particularly innovative, and in some cases anti-establishment, companies are names such as Soft Bank (mobile telecommunication) and Rakuten (e-commerce). Investments in these companies continue to offer potential rewards – irrespective of Mr Abe’s success.

Meanwhile, there is a long list of companies whose business models are closely tied to the success of Abenomics. Their share price performance gives a particularly good reflection of the mood for or against Mr Abe. One example is TV Asahi Corp. Its share price has been boosted by hopes of rising advertising revenues on the back of a general economic upturn. Automotive supplier NGK Spark Plug is another case in point. Its international competitiveness is set to improve thanks to a weak yen. In addition, both companies are highly innovative and occupy attractive niches with strong market positions.

In awarding asset management mandates for the LGT Select Equity Japan as a component of the Princely Strategy, we therefore attach great importance to portfolio manager selection. We seek out those able to identify, at an early stage, successful long-term business models among the first group of companies listed above. Alternatively, we look for portfolio managers who are flexible and opportunistic enough to sense the mood in the market and continually adapt the portfolio accordingly.

On a more general note, some of LGT’s overall selection criteria apply specifically for Japan as this has proven to be a very difficult market for active management since the early Nineties.

Investment teams with long-standing experience, individual skills and institutional client base in this problematic phase are more important to us than a retail-oriented client base and process-driven approaches, in which the individual skills of portfolio managers seem to be less relevant. As such we have a bias towards boutique managers with strong personalities leading the investment process. We prefer either bottom-up driven, benchmark unconstrained people with a long-term view on their investment cases or more top-down driven, opportunistic managers  with a proven track record of successful mid-term rotation of favourite market segments.

With the two managers Morant Wright and Dalton Japan, our portfolio is built along those lines, and we are invested in most of the companies mentioned above. Morant Wright has a more long-term, bottom-up, defensive philosophy, executed by an exceptionally experienced investment team. In contrast, Dalton Japan takes an opportunistic, more top-down oriented approach with a quicker rotation of favourites, which has proven supremely successful over the last 20 years, executed by an extremely strong lead portfolio manager.

Dalton Japan (re-branded from Funnex) is the rare case of a Japan based boutique manager who has fully convinced us with a Ucits-compliant offering.  Many local managers rely on processes that are too much number-crunching, short-term, retail-oriented. Or they have offerings that only apply to a Cayman structure. In general, we find more interesting, Ucits-compliant names for Japan located in the Anglo-Saxon world. Database screens for idea generation have proven to be ineffective in the case of Japan equity managers. Valuable ideas basically result from good networking.

With Japan now having a fair chance to overcome some of its structural problems of the last two decades, a higher beta profile of the Select Fund seems to make sense. Another manager will be added to the portfolio later in the year, bringing to the table such a higher beta profile and providing a foil to Morant Wright. However, even with its relatively defensive profile, our strategy has fared well to date in the era of Abenomics.     

Volker Hergert, Portfolio Manager Multi-Asset Class, LGT Capital Management