Seeking growth opportunities in Japan

By Asset Management One

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Japan offers global investors an ever-increasing number of growth focused companies that are tapping into domestic as well as global growth sectors.

After spending most of 2021 under some form of Covid-related restrictions, Japan is re-opening for business. Vaccination rates have picked up rapidly through late spring and summer. The number of daily new cases has plummeted. A new Prime Minister has taken office, promising to re-ignite growth.

It may thus be an auspicious time for investors to revisit exposure to the land of the rising sun. The Japanese equity market has been led so far this year by economically sensitive, value stocks, in anticipation of the economic re-start.

How should investors position for the next phase?

Over the past decades, many of Japan’s structural challenges have been well documented - be it the mature, low growth macro background, the cyclicality of corporate profits and the equity market, or the challenging demographics. Nonetheless, Japan remains an important building block of a diversified equity portfolio for global investors. It is still the single largest developed market outside the US.

There are over 3,700 companies listed in Japan, with a combined market capitalization approaching US$ 7 trillion. It is a broad, diverse market, offering investors exposure ranging from large cap, liquid global champions – “household” names such as the well-known automotive, robotics and electronic components companies – all the way to small, fast growing domestic companies operating in niche sub-sectors.

A significant number of companies, especially - though not exclusively - at the smaller end of the market capitalization spectrum, provide compelling exposure to structural growth themes in Japan.

One such structural growth theme is digitalization. The first generation of IT services companies such as Softbank, Rakuten and Cyberagent have been mainstays of Japanese portfolios for over two decades, but overall Japan lacks a large cap IT services sector.

However, a new generation of IT services companies has emerged in the past few years, seeking to bring digital transformation to areas that are still inefficient in Japan. Innovative new IT services are being deployed in fields ranging from public administration to finance, retail to advertising. New listings of IT services companies in recent years have brought to market companies operating in fields such as e-commerce, cloud services, payment services etc. Led by a newer generation of entrepreneurs, such companies often aim for commercial success

whilst also hoping to address social challenges - for example by introducing or supporting new working practices, in a move away from Japan’s rigid labour practices of the past. Digitalization is also one of the focus areas of government policy, with a new government department set up this year to support Japan’s progress. A fiscal stimulus package due to be unveiled later in 2021 is expected to provide budgetary support for Japan’s ongoing digital transformation efforts.

Another structural growth theme rising to prominence is de-carbonization and the transition to net zero. As an energy importer with limited natural resources of its own

and a sizeable industrial sector, Japan has been a slower convert to the path towards a zero-carbon economy. One year ago, however, the government issued its “Net Zero 2050” pledge, and corporate Japan has stepped up efforts significantly in recent months. Perhaps more importantly, a shift of mindset appears to be taking place from seeing the energy transition as a threat to Japan’s economic growth prospects, to embracing it as a source of opportunity.

Such opportunities abound – from pure play renewable energy providers in the solar and offshore wind industries, to global consortia focused on advancing hydrogen

technologies, to Japan’s electronic components manufacturers seeking to tap into growth opportunities generated by the electrification of the internal combustion engine.

With the world slowly emerging from the Covid-19 pandemic, healthcare remains in focus as another area of secular growth. In Japan, challenging demographics mean delivering high quality health and nursing care in a cost efficient way will remain a key policy and society goal. Here too Japanese companies are identifying and building on structural growth opportunities – in medical big data, in minimally invasive medical intervention, in drug discovery in areas such as Alzheimer’s, in nursing care etc.

Some of these structural growth themes, and the stocks that represent them, have performed strongly during 2020, as interest rates came down globally to support economies through the pandemic. This year, with successful vaccination programs well under way both globally and, more recently, in Japan, investors switched to old economy stocks in sectors such as shipping, air transport, wholesale trade and manufacturing. Such stocks enjoyed the benefit of lower valuations and the tail wind of economic re-opening.

In contrast, structural growth stocks have made relatively less headway so far this year. However, the valuation gap favoring old economy cyclical stocks is becoming less compelling. Structural growth stories that successfully tap into societal needs and long term economic trends should be well placed to re-assert their place in investor portfolios going forward.

Disclaimers

Asset Management One International Ltd. is authorised and regulated by the Financial Conduct Authority in the UK. The value of an investment portfolio and the income from it may fall as well rise and investors may not get back the amount originally invested. Past performance is not necessarily a guide to the future. This data is intended for professional investors and eligible counterparties only, as defined by the Financial Conduct Authority, and is not intended for further distribution.

IMPORTANT INFORMATION

International investing entails special risk considerations, including currency fluctuations, lower liquidity, economic and political risks, and differences in accounting methods; these risks are generally heightened for emerging market investments. Concentrating investments in one region subjects the Fund to more volatility and greater risk of loss than geographically diverse funds.

Equity stocks of small and mid-cap companies carry greater risk, and more volatility than equity stocks of larger, more established companies. The above is for informational purposes only and should not be considered as an offer, or solicitation, to deal in any of the investments mentioned herein. AMOI does not warrant the accuracy, adequacy or completeness of the information and materials contained in this document and expressly disclaims liability for errors or omissions in such information and materials.

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