What’s driving Japanese equities

While Japan’s equity market has lagged behind the U.S. and others, a strong global economy and potential corporate governance changes could lead to opportunities, according to Walter Scott’s Murdo MacLean.

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In 2019, the MSCI Japan Index rose about 20% in U.S. dollars, according to MacLean, client investment manager at Walter Scott in Edinburgh, U.K. That’s compared to returns of 28% for the MSCI World Index and almost 32% for the MSCI U.S.A. Index.

While it returned “quite a nice level, it did lag global benchmarks,” said MacLean in a Jan. 7 interview.

The reason for the lag? Japan’s economy and equity market is “highly sensitive to the global macro backdrop,” said MacLean, who manages the Renaissance Global Growth Fund and the Renaissance International Equity Fund.

“This stems from its exposure to sectors such as autos and electronic components and, indeed, the semi-conductor supply chain. These are typically more cyclical than your average corporate.”

Another factor impacting Japan’s economy is recent tax reforms. In October, the country imposed a second hike to its consumption tax, raising it from 8% to 10%. The move was meant to help balance the country’s net debt to GDP, which is around 150%, MacLean said.

The move has “gone through fairly smoothly,” he said. Despite the hike, fourth quarter stock returns were “actually quite healthy — just over 7% in U.S. dollar terms.”

The scandal involving Nissan and its former boss, Carlos Ghosn, has also forced the country to deal with “structural issues, particularly with respect to corporate governance standards,” MacLean said.

“These long-awaited improvements to corporate governance structures, and potentially more generous distributions to shareholders through dividends and share repurchases, offer investors reasons to potentially consider Japanese stocks going forward,” he said.

The IMF upgraded its forecast for Japan to 0.7% growth in 2020 from 0.5%, citing Prime Minister Shinzo Abe’s recent stimulus package.

Where are the opportunities?

MacLean’s firm takes a buy-and-hold approach to Japanese equities.

“Our average holding periods are around the 10-year mark,” he said. “So given that we tend to invest and hold businesses for quite a long time, that also affords us the opportunity to engage with [companies] on issues, such as corporate governance and shareholder returns.”

FANUC and Shin-Etsu Chemical are two companies his firm has been invested in for almost 30 years.

As of earlier this week, FANUC’s stock had gained more than 16% over the last year, while Shin-Etsu Chemical’s was up more than 48%, according to Bloomberg.

“Our expectation would be that these companies continue to possess the qualities to contribute materially to client returns in the next three, five, and beyond years,” said MacLean.

Many of his holdings are in Japan’s technology, industrials and healthcare sectors, which “possess some world-leading companies” due to “a good history of innovation,” MacLean said.

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