Chief Investment Officer Daiji Ozawa talks about how corporate governance could support Japanese equities in 2020.

Nov 19, 2019 | Daiji Ozawa
 

 Key takeaways

• Japan has reached a tipping point for the exercise of active ownership sparking corporate action to improve governance among Japanese.
• Despite the near-term earnings challenges, total shareholder returns are expected to reach a historic high.
• A surge in supporters of Task Force on Climate-related Financial Disclosures (TCFD) during 2019 signals that Japan has taken the initial step in climate change.

Global political and macro headlines mostly took centre stage in throughout 2019. Against the backdrop of central banks’ dovish policies and some progress in the US-China trade talks since autumn, investors have restored confidence with expecting a turnaround in an earnings cycles, and Japanese equities benefited it and outperformed the other major markets in late 2019. Meanwhile, looking forward to 2020, we believe that long-term structural perspectives, namely unfaltering corporate governance reform, also support Japanese equities on a sustainable basis.

A recent revival in activist investors could be one of the evidence that Japan has reached a tipping point for the exercise of shareholders rights (see Chart 1).

Chart 1: Activist investors' holdings of Japanese stocks

Notes: Activists are activists listed in FactSet's Shark Watch 50 list of global activists plus Japan-only activists. Universe for liquidity-on-hand / assets is TOPIX constituents excluding financials and Japan Post. Sources: FactSet, QUICK, SMBC NIKKO

In the noughties, hard activists made an abortive attempt with often just demanding payback of a chunk of cash or launching a hostile takeover bit, a resulting rise in takeover defences among Japanese companies. For the last couple of years, however, activists have returned and tend to take a soft engagement approach, which tallies with the last five-year improvements in corporate governance standards with an emphasis on constructive dialogues between investors and company management. For instance, Olympus, a company which used to be best known for its camera and is now a global leader in endoscopes, accepted an external director from a US-based ‘soft’ activist who only has minority ownership with approximately 5%. Since then, the company offered a share repurchase programme to unwind strategic shareholdings with Sony, restored legal allegation-hit US business and announced a mid-term plan with a focus on core medical business aiming to double its operating margins.

And the ripple effects have been spreading. Recruit, a company with a dominant position in staffing services owning Indeed, as well as information providing services, announced a non-dilutive secondary offering to unwind shares owned by large shareholders combined with a share buyback plan to absorb part of its offering. Then, Dai Nippon Printing (DNP), one of Recruit’s large shareholders, decided to spend the cash raised to buy back their own shares absorbing approximately 10% of total shares outstanding from the market. Due to poor corporate governance practices, including extremely low capital efficiency with return of equity of around 3% and a multitude of cross-shareholdings, the increasing number of investors has cast their proxy votes against the company management, which is now eventually bear fruit. Emerging active ownership in Japan has also put pressure on factory automation sensor specialist Keyence. The company, renowned for not only high operating margins but also significantly hoarding cash on the balance sheet, surprised the market with the announcement of a two-for-one stock-split doubling the total amount of dividend pay-outs. Despite the near-term earnings challenges, the Japanese companies overall have nearly doubled the share buybacks plan for 2019 on a year-on-year basis (see Chart 2), and total shareholder returns are expected to reach a historic high (see Chart 3).

Source: Company data, Nikkei Value Search, Data compiled by Goldman Sachs Global Investment Research.

These facts underpin our long-term constructive view that responsible proxy voting and constructive engagements are rising, and corporate governance is making strides as a result. Corporate governance reform continues to progress slowly but surely leading improvements in capital efficiency and profitability in Japan. Active ownership has been taking root in Japan.

In addition to governance, environment, to be specific climate changes, is becoming material issues for investors globally. In order to bolster sustained corporate value creation and deliver strong, long-term investment performance, we do believe that it is inevitable for both company management and investors to confront the climate agenda. A surge in supporters of Task Force on Climate-related Financial Disclosures (TCFD) during 2019 signals that Japan has taken the initial step in the agenda. As a long-term investor, our priority in this matter is a deeper understanding of business model and strategies on climate-related risks and opportunities. We keep our eyes on the next steps, effective reporting to demonstrate how companies have prepared or are preparing for a lower-carbon economy, and the third step, properly implementing strategies to meet their targets alleviating financial risks and improving their competitive advantage. 

Daiji Ozawa is Chief Investment Officer for Invesco Japan.
 

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