Winners and losers: the case for investing in Japanese equities

Dean Cashman, Sydney-based executive vice-president for BT Funds Management, says now is the time to invest in Japanese equities as corporations deal with restructuring and new technology simultaneously. (Principal maintains the BT Funds brand in Australia only.)

He notes in the US, companies restructured in the late 1980s and early 1990s, and embarked on a technological transformation starting in the mid-1990s. European companies restructured in the 1990s and have recently also focused on integrating IT. Japan Inc. faces both requirements now. As a result: “This is a process of winners and losers; it’s not a macro call,” says Cashman.

He believes Japan is at the start of a long-term process of fundamental change in how corporations allocate capital. Those with the vision and cashflow to reinvest and restructure will do well; the rest will fail, regardless of sector. Principal argues this kind of environment requires a clever fund manager with a good nose for risk.

The low returns that investments by Japanese companies have provided are no longer sustainable. That failure is eroding cross ownership and the intergroup relationships between corporates and financial institutions. Thanks to short-term momentum investors pulling out of the market this year, there is weakness – which he reads as value. Nor will a soft landing of the US economy derail this process, because corporate Japan is changing not because of a cyclical upturn but because restructuring and IT investment is a desperate bid to survive.

Similarly the government is interfering less, Cashman believes. While the bureaucrats still support construction companies such as Kumagai Gumi, they can’t save losers such as Chiyoda Mutual Life Insurance or Sogo. Increasingly, borderline cases will go bankrupt rather than be bailed out. Furthermore, the government very recently is moving to change the commercial code to enable internet-based transactions, as well as to encourage the bureaucracy to cut red tape by embracing IT-based processes.

Favourite stocks include Orix, a leasing company with a distribution network the company is trying to leverage with new products, such as mortgages; as of end-August Orix comprises 4.34% of the fund’s portfolio. Cashman cites retailer Toys R Us Japan as another company getting it right.

He also likes NTT DoCoMo for its franchise, management, control of its intellectual property and HTML language-based internet protocols. But NTT DoCoMo and parent Nippon Telephone & Telegraph (NTT) are interesting trading stories. NTT DoCoMo made up 8% of the portfolio at the start of the year but at Y4.5 million per share Cashman found it overvalued. He cut his stake to 1% of his portfolio; since then the price has fallen to Y2.5 million and he’s building the position again; now it stands at 3% and growing. Parent NTT is now the biggest holding in his portfolio, at 8.54%, but he’s starting to cut back, partly because the government intends to sell its stake and partly because of index vendors moving to adjust for free float (NTT’s current weighting in Japan equity indices is greater than its publicly available float).

Principal’s Japanese equity fund launched 1 August. Domiciled in Dublin, the fund’s minimum investment size is $2 million for institutions and $10,000 for individuals, and carries a 1.75% management fee and a 0.5% administration charge. Principal manages $1.2 billion in Japanese equities for retail and institutional clients.