Two quite different outcomes to elections in the US and Japan in recent weeks have put the spotlight on the Japanese market. There are some clear observations to be drawn from this.
By Paul ffolkes Davis, Chairman of Rising Sun Management, Investment Advisor to NAVF
Prime Minister Shigeru Ishiba retained power but lost the Liberal Democratic Party’s majority, obviously making a big mistake in calling the 27 October snap election. Like the Democrats in the US, Ishiba didn’t seem to comprehend just how disaffected people all over the world are with incumbent regimes.
The fact that the Liberal Democrats have clung on to power, for now, means they are in a much better position than the stateside Democrats. His diminished political stature is a result of few expecting any change from the status quo ante under Ishiba, a stolid, uncharismatic four-decade veteran of Japan’s House of Representatives.
Supportive policy
From the standpoint of macro-economic and regulatory policy, we believe that things continue to be set fair for Japan equities. The new minority government may be less hawkish on driving JPY higher than the previous Prime Minister Fumio Kishida, but we do expect the yen to stabilize and push higher again over time as it was doing.
That said NAVF portfolio gains are denominated in yen since we don’t hedge the currency. Thus, how JPY moves on foreign exchange markets has an effect on returns in GBP. It is the case that recent weakness in JPY has reduced the value of NAVF by almost 8% following on from initial uncertainty over the Japan election result and a further decline after Trump’s comprehensive victory in the US election.
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Governance reforms ongoing
For us, the key driver of our activist investing in small and mid-cap Japan companies is the corporate governance reform program initiated by former Prime Minister Shinzo Abe in 2012 and enhanced every year since. It is a policy goal to have the number of public companies on the Tokyo Stock Exchange (TSE) shrink from the near-4,000 currently listed.
In pursuing this, the Ministry of Economy, Trade & Industry (METI) has continued to chip away at outmoded protections to make life difficult for underperforming companies. In the past it was easy for a listed company to resist a takeover bid, but changes introduced in 2023 mean that if an approach is made, the target must appoint an independent board to evaluate it, and it must engage with the putative acquiror.
Japan’s corporate governance reform program is a key enabler of NAVF being able to create and extract value for investors with our activist approach. What’s more, the opportunity that we identified nearly five years ago when we brought NAVF to market in February 2020 remains compelling.
Attractive valuations for Japanese small caps
One simple measure shows this. A year ago, more than half of the firms on the TSE traded at below 1x book value. Today about 40% of listed companies are still below this threshold, underscoring just how broad the opportunity remains.
In addition, to attractive book value, NAVF also seeks to buy shares with a high margin of safety. This can include substantial levels of balance sheet cash, crossholdings in other companies, and non-operational assets, such as property or even large corporate art collections.
We believe that the companies NAVF invests in will not only survive but prosper – and reward shareholders – through the actions that we undertake to create value. There are still many companies in NAVF’s target group. In fact, we have initiated new positions in several companies during November.
Trump impact on Japanese stocks
Obviously the impact of the Trump sweep – winning the White House and both chambers of Congress – may have significant repercussions for many countries, including Japan. Trump’s preference for tariffs to rebalance trade in favor of the US could potentially have a big impact on large cap exporters like Toyota Motor Corp or Sony.
However, the small and mid-cap companies, with a domestic business focus, that NAVF invests in tend to have low exports and the currency is not normally a factor to the same extent it is for the large exporters. We believe that this makes our portfolio companies less vulnerable to currency fluctuations and the Trump trade regime over time.
We are also optimistic that the effect of change in Washington DC could be slightly more nuanced than many observers expect. The US needs allies in south-east Asia, given Trump’s anti-China positioning, and Japan is the number one ally in the region. What’s more, Japan can raise military spending further and focus on buying weapons from US manufacturers, thus appeasing the new administration.
China trade unwinding
Nevertheless, China will remain an important factor in NAVF’s portfolio. Many Japanese companies have joint venture companies in China or plants located there. The growing pressure to curb and reverse economic ties means there will be less trade with China and investment there and, therefore, the need to unwind this exposure over time.
We have seen that when Japanese companies restructure, among their first actions is to sell Chinese assets. This happened with T & K Toka, a chemicals company we invested in, which sold a stake in a Chinese joint venture late last year and used the cash to help fund its tender offer to shareholders.
To conclude, we continue to be highly optimistic about the activist opportunity on offer for investing in small and mid-cap Japan stocks. This has paved the way for an approximately 90% gain in our NAV since launch almost five years ago, and we expect that further value will be created for shareholders in 2025 and beyond.
