Nicholas Price, portfolio manager of Fidelity Japan Trust PLC, discusses why he maintains a positive outlook for Japanese stocks. In particular, he outlines why he expects the Japanese market to be driven by strong fundamentals and positive corporate earnings surprises.
While new Covid-19 variants clearly pose near-term risks, we believe that the continued monetary and fiscal stimulus as well as the gradual vaccine rollout are positive for the global growth outlook and should be supportive of Japanese equities.
A number of themes present themselves. Certainly, clean energy and environmental efficiency are areas where Japan has some very competitive companies that can supply solutions to meet the regulatory and productivity needs of customers globally. Covid-19 has also accelerated trends in e-commerce and digitalisation. As profits recover, companies will prioritise those areas.
One such example held in the Trust is Mitsui High-tec, a major player in the global motor core market, an essential component of power-train motors in electrical vehicles (EV) and hybrid vehicles. In the internet space, Coconala is a unique online C2C freelancing platform that enables users to trade knowledge, skills and experience. We first invested in the company as an unlisted security in 2019, recognising it as a beneficiary of the many structural changes occurring in Japan’s labour market, and attracted by its high and sustainable growth rates, as well as the high operating leverage of its business. Coconala recently had a strong debut on the Tokyo Stock Exchange and the value of the portfolio’s holding increased more than threefold.
Opportunities in ESG
Globally, the uncertainty wrought by Covid-19 has shone a light on sustainability- and Japan is no exception. Although Japanese companies generally have lower sustainability scores than their European counterparts, we believe this is not due to any fundamental differences in strategy - but more to do with cultural reasons around disclosure practices and language.
By working closely with our sustainable investing team on the ground in Japan, we are able to identify laggard companies that are implementing real change and moving up the governance scale. As these companies improve disclosure, ESG ratings should catch up and the market should adjust valuations accordingly. For investors, this creates an opportunity to benefit from the correction.
As an example of our ESG-related activities, I would highlight NOF Corp, a diversified chemicals company that we hold in the Trust, with which we actively engaged through the year on the themes of climate change, waste and pollution, and governance.
We engaged with the company at the start of 2020, focusing on its low ESG rating and potential improvement measures. We highlighted that the quality of its business and products was not fully reflected in its share price due to ESG-relates issues. Management accepted that this stemmed primarily from poor disclosure on chemical safety and carbon emissions, as well as their reluctance to engage with shareholders.
The company committed to dealing with these issues. The first positive outcome was a meeting with the CEO, who had never met with investors before, to further discuss ESG-related initiatives and disclosures. Following further meetings by our investment team, the company announced new medium-term financial targets, which positively surprised the market as it represented a first constructive commitment to shareholders. This was followed by the release of its first integrated report and a detailed ESG data book, which now constitutes best practice and included our recommendations: a reduction plan for CO2 emissions and the establishment of a procurement policy that encompasses environmental and human rights issues.
Misumi Group, a factory automation supplier, is another company we think could potentially improve its ESG rating. It ranks low on ESG despite its business of delivering efficiency solutions. We are currently in discussions with the company and the management understands its ESG ratings gap comes from poor disclosure.
Over time, we think executives at Japanese companies will treat the disclosure of sustainability as important as financial data. Finding those companies that will disclose sooner and better, perhaps by engaging with them, will potentially create additional opportunities for excess returns on investments.
Positioning for recovery
Overall, I am cautiously optimistic on the investment outlook for Japanese stocks in 2021. I am also looking to widen the net a bit further and find companies with recovery potential in areas such as leisure and travel as the vaccination rollout in Japan accelerates from here. As we start to see better earnings announcements in fiscal 2021, there will be an opportunity to pick up companies that are changing into or returning as growth names.
Japan continues to offer a wealth of under-researched mid/small cap growth companies, where we typically find better business models and returns on equity, and management is more incentivised in terms of shareholder returns.
Active managers such as myself, based here in Japan, have the opportunity not only to invest in established global leaders, but also to unearth less well-known companies (including pre-IPO), where lower levels of analyst coverage can often create some great mispriced opportunities.
In an uncertain environment, our in-depth research and on-the-ground knowledge is invaluable when looking at the micro level and speaking to company management to fully understand the current dynamics.
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