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Turning Japanese: Equities in the Land of the Rising Sun

22 Jan 2018

Attractive valuations, improving governance and rising returns could make Japanese equities a good fit for cash-flow-hungry pension funds. Mark Dunne takes a look.

“The pendulum is swinging towards the shareholder and away from some of the traditional concerns that have dominated corporate governance.”

Eric Lonergan, M&G Investments
Japan is living up to its billing as the land of the rising dividend. Japanese companies handed ¥12trn (£87bn) to shareholders in 2016, compared to the ¥8trn they paid in dividends nine years earlier. Further growth is expected as the government increases pressure on boards to deploy the huge cash piles they have traditionally sat on. The 30% pay-out ratio recorded in 2016 is largely thanks to reforms introduced by Prime Minister Shinzo Abe. After a debt fuelled equity bubble popped in 1989 the country has struggled against low growth, deflation and a national debt stretching to 229% of GDP. Rising longevity and low birth rates have also hindered attempts to revive the economy. Breaking the cultural practices that have kept some companies in their comfort zones, where they hoard cash and treat shareholders with indifference, has been one of Abe’s core reforms. This has included setting return on equity targets and appointing more independent directors. The intention is to boost corporate earnings and investment as well as improve governance, which should whet the appetites of cash-flow-hungry investors. “A greater focus on capital efficiency and shareholder value is helping to put Japanese corporates, and in turn, the broader economy on a sustainable growth path and rekindle lasting interest in Japanese equities among global investors,” Jun Tano, who manages the Fidelity Institutional Japan fund, says. Eric Lonergan, a macro fund manager at M&G Investments, believes that this translates into an implied real return of 7% in the medium term, based on the earnings yield. “Now that in the context of where global developed market assets are is, of course, a huge level of real return,” he says. Alongside dividends, companies have also used their cash to improve shareholder value through buy-backs. In February, tyremaker Bridgestone took advantage of a depressed share price by spending ¥150bn on buying around 6.5% of its shares, which were then cancelled. This is a growing trend. In 2016, company boards, under pressure to deploy their huge cash reserves, took advantage of attractive valuations by spending ¥5trn on such schemes, up from ¥4trn in 2007. Another way directors are using strong balance sheets to improve shareholder value is to visit the M&A market. One example is Softbank’s acquisition of Arm in 2016. “So rather than sit on that cash they are starting to put it to work in looking for higher growth, higher return investments or return it to shareholders,” Helen Driver, a fund manager in Aviva Investors’ Global Equities team, says. Driver believes that governance reforms will continue to fuel dividend and buy-back growth. “This focus on returns for shareholders is very much an ongoing theme,” she adds. Making a more efficient use of this capital not only takes the form of dividends and buy-backs, but also investing in the future growth of the business or boosting wages to encourage consumer spending. Return on equity among Japanese companies is expected to continue growing, which means it could be an investment suitable for pension funds. “Long-term it [Japan] makes sense,” Cedric Le Berre, senior analyst at Union Bancaire Privée (UBP), says.

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