Aberdeen Japan Investment Trust's Kwok Chern-Yeh argues that the country's strongest businesses are robust enough to survive and thrive in the most difficult environments.
The Japanese stock market has been in a sweet spot. As global growth has improved and domestic economic reforms have come to fruition, they have benefited Japan’s outward-looking economy. Its companies have shown strong growth and earnings, drawing in international investors. The country’s stock market saw a buoyant year in 2017 and many believed that Japan had put its worries firmly behind it.
However, we would caution against excessive exuberance. While progress has been made, Japan’s economy still has some well-documented problems, such as high debt. Its demographics are poor even by developed-market standards, and the strength of the currency is a perennial headwind. If the world economy were to turn lower, some of its companies could find themselves tested. While there is no immediate cause for concern, the potential for international trade wars and ongoing geopolitical tension pose a risk. Japan is not at the forefront of this, but it may suffer in the crossfire.
The strongest Japanese companies have long shown themselves capable of dealing with difficult environments, however. The companies we look for in the Aberdeen Japan Investment Trust have demonstrated themselves capable of dealing with a deflationary environment, an erratic currency and Japan’s enduring economic problems. In our view, this means these companies are often more robust than those found elsewhere in the developed world.
The companies in the portfolio have considerable financial resources, designed to provide a buffer if the macro economy worsens faster than expected. Moreover, these companies recognise that potentially game-changing events such as the trade issues between China and the US also present opportunities; their stronger finances allow them to take advantage where less well-resourced competitors cannot.
The power of robots
A good example of this type of resilient company is in the field of robotics. Japan continues to lead the world in robotics development, with groups such as Keyence and Nabtesco.
Keyence manufactures automation sensors, vision systems, barcode readers and laser markers. Its products are at the cutting edge of factory automation and helping to reduce labour costs. Its end markets have been growing stronger as Chinese wage costs have risen, driving the need for greater efficiency. Nabtesco’s reduction gears are a key component in industrial robots. We also hold Fanuc, the largest robot-maker in the world.
Japanese companies are also at the vanguard of certain areas of healthcare. We are invested in companies such as Chugai Pharmaceutical. This Roche subsidiary makes drugs for haemophiliacs, with promising recent results in clinical trials. There are also a number of healthcare equipment companies. One of our holdings makes haematology analysers and DNA-based screening tools. It has significant market share, but also a strong business model. Once it has sold a machine, it has a captive market for components and upgrades.
The China opportunity
Japan also has some geographic and cultural advantages when selling into China. Many Japanese companies have succeeded in building their businesses in China, where Western brands have struggled. This allows them to tap into the rising wealth of China’s burgeoning middle classes and their desire for premium products. Many Japanese consumer goods companies have good brand recognition and are trusted as quality producers.
This is the main driver for the trust’s overweight position in consumer goods relative to its benchmark. We are focused on more defensive names that may perform in all market environments and have good visibility on earnings. For example, we hold Pigeon Corporation. China has become Pigeon’s largest overseas business, accounting for a third of its total sales. This is driven by the group’s babycare segment – Pigeon’s baby bottles are perceived to be of better quality than those of their local rivals.
Cosmetic company Shiseido is another example of a company with a good pan-Asian reputation and an understanding of the Chinese market. It has been steadily growing its earnings in the region.
A more difficult environment
In our view, this type of company can do well in spite of the currency or the Japanese economic environment. Such businesses tend to produce where they sell their goods and are therefore less vulnerable to fluctuations in the yen. They can also sit outside the flip-flop of exporters versus domestic stocks within the Japanese market, and hence their profits are more consistent.
There is a resilient group of Japanese companies that has seen these types of problem before and is well-equipped to deal with them. Valuations in Japan look undemanding relative to other developed markets. We believe selective investment in Japan can improve a portfolio’s resilience to any shift in the global economy and provide access to unique companies.
Kwok Chern-Yeh is senior investment manager of Aberdeen Japan Investment Trust.
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