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Resilient Japan ripe for investment

3 Nov, 2021

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By Chern-Yeh Kwok, Investment Manager, Aberdeen Japan Investment Trust PLC

Just as a virulent pandemic prevented overseas visitors from attending Tokyo’s Olympic and Paralympic games over the summer, so it’s likely discouraging international investors from seeking opportunities in Japan.

Yet the act of having staged this quadrennial sporting showpiece in the face of such adversity epitomises a characteristic of modern Japan that investors would do well to take more notice of: resilience.

Despite obvious disappointment that spectators were, for the most part, unable to attend the games, and the political uncertainty triggered by Prime Minister Suga’s recent resignation, now could be an opportune time to invest in Japan. Data indicates its economy is recovering, with manufacturing activity picking up as economies globally start to reopen from pandemic-enforced shutdowns.

Japan’s exports to China are surging, while exports to the US and Europe have also rebounded from the lows of last year1. This serves as a timely reminder that Japanese companies are highly leveraged to recovery in the global economy, across industries from autos to semiconductor-making equipment.

Decades of economic hardship at home have driven Japan’s leading firms to build their brands overseas in search of growth and inspired a bold approach to innovation. Today, Japan is a global pioneer in automation technologies, notably robotics. Manufacturing automation remains key in China to saving on labour costs and improving product quality.

The recovery in global consumption this year amid vaccination roll-outs is trickling down into the earnings outlooks of Japanese firms, many of which posted strong first-quarter results.

The following companies are selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.

Amada, for example, which makes machines for processing sheet metal, has seen a robust recovery in orders. So, too, auto-lighting specialist Ichikoh Industries has raised its full-year profit guidance, while semiconductor-manufacturer Sanken Electric is enjoying a rebound in sales growth.

Domestic consumer spending is also improving. Shrinking demographics ensure unemployment remains low in Japan, while labour market institutions provide protection to household incomes. These factors provide a job security – and support for spending – that few countries can count on.

Although Tokyo’s hospitals remain under strain, infection rates are falling and Covid restrictions are expected to ease soon, while Japanese authorities have accelerated their vaccination programme at speed, after a sluggish start.

With precautionary savings high among the local population as a result of the pandemic, even a partial unwinding of restrictions is likely to give a further lift to consumer spending. Luxury hotels operator Resorttrust, for example, is in line to benefit from pent-up demand for leisure and travel activities.

Another key factor for investors is that, by necessity, Japanese businesses have built strong capital positions to counter domestic economic difficulties. Non-financial firms hold more than 20% of their market cap in cash, on average, versus less than 10% in the US2.

This enables them to capture opportunities as conditions improve. Now we are seeing a broad-based pick-up in corporate spending as businesses that had put expansion plans on hold amid the pandemic look to invest in their own growth. This is designed to drive profitability, which is likely to be positive for share-price performance over time.

Contrary to common external perceptions, Japan offers a rich source of investment opportunities. Of more than 2,000 stocks in the Topix, over 40% are not covered by analysts. This allows active investors to unearth hidden value, especially among the many smaller, less-well-known firms.

One in seven Japanese stocks rose by 500% or more in the decade to September 20203, underlining how company performance doesn’t necessarily reflect weakness in the domestic economy.

We see promising areas of structural growth such as digital transformation, interconnectivity and health technology. Japan’s social care bill is rising at a time when its working population is shrinking. But innovative medical equipment firms continue to invest in R&D to maintain a competitive edge.

We also see new trends emerging as economies worldwide adopt policies to address environmental sustainability. A number of Japanese firms offer cutting-edge technology to bridge the transition to green energy.

Examples include Takuma, a leading biomass power and waste incineration plant provider whose products help cut carbon dioxide emissions; and Sanken Electric, which makes energy-saving chips that reduce CO2 emissions for white goods.

Environmental, social and governance (ESG) standards are another potential growth area for investors. These are not only essential to managing risks, but also can help to enhance the value of businesses.

We have found management and product assurance at Japanese firms to be world class, yet many are not disclosing this to the market. We discovered an auto company keeping its stringent processes for maintaining quality and safety standards a secret. Disclosing this could broaden investor understanding about its competitive strengths and potentially drive up its share price.

Similarly, we found a baby products firm making praiseworthy progress on carbon emissions and sustainable sourcing, but again this was going unrecognised. Disclosing processes for selecting raw materials can be a good selling point for products.

Overall we see a brightening outlook for Japanese firms as beneficiaries of the reopening of economies worldwide. From a political perspective, a general election lies ahead but broad policy continuity and near-term fiscal stimulus is the likely outcome. At the same time, investors might anticipate a rebound in domestic spending as vaccinations gather pace and Japan’s economy reopens for business.

Important information

Risk factors you should consider prior to investing:

• The value of investments and the income from them can fall and investors may get back less than the amount invested.

• Past performance is not a guide to future results.

• Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.

• The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.

• The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.

• The Company may charge expenses to capital which may erode the capital value of the investment.

• Derivatives may be used, subject to restrictions set out for the Company, in order to manage risk and generate income. The market in derivatives can be volatile and there is a higher than average risk of loss.

• Movements in exchange rates will impact on both the level of income received and the capital value of your investment.

• There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.

• As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.

• Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.

Other important information: Issued by Aberdeen Asset Managers Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Registered Office: 10 Queen’s Terrace, Aberdeen AB10 1XL. Registered in Scotland No. 108419. An investment trust should be considered only as part of a balanced portfolio. Under no circumstances should this information be considered as an offer or solicitation to deal in investments.

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