Japan has been an interesting hunting ground for investment opportunities in the Fidelity Global Special Situations Fund for some time. Contrary to popular perceptions, in like currency terms, Japanese equities have kept up with global equities over recent years and there are reasons to expect the market to outperform from here.
Currently, despite businesses witnessing new highs in terms of corporate profitability, the Japanese market remains well below levels seen in the 1980s. In fact, a meaningful part trades at a market value below book value and, across the market as a whole, companies have near zero debt – very unusual in an international context.
At the same time, valuations versus the rest of the world are near record lows, whilst corporate reform and increased shareholder focus continue to move in the right direction. Not only are businesses more focused on return on equity, there is a distinct change in how companies are approaching governance, with board members now needing to justify cross shareholding patterns and cash holdings on the balance sheet.
After reducing holdings in 2017, it appears that international investors are now returning and this is a good sign for the short-term, since the market’s relative performance has in the past been strongly driven by foreign investor flows.
The caveat in all of this is that the Japanese market tends to be sensitive to global economic trends and there are some clear geo-political risks in the broader region. However, recent economic strength is not just the result of trade-related demand but reflects a real (some would say surprising) improvement in domestic demand conditions. In this context, we will be following developments around expected Japanese tax reform very closely in the coming period.
At this point, it seems appropriate to hold a mixture of domestic and international-focused businesses with company-specific fundamental drivers. These include opportunities in the technology sector, where names such as Alps Electric and Renesas represented exceptional value at the time of investing.
The former, which supplies smartphone camera actuators and haptics to Apple and Nintendo Switch products could see a volume uplift from its participation in the auto infotainment category. Renesas Electronics, a semiconductor company, has been struggling in previous years, but has now seen success in winning non-Japanese business in auto-related microcontrollers.
Similarly, Softbank, which has a stable domestic telecoms business, represents a compelling corporate change opportunity following its acquisition of ARM, which signalled a broadening of approach to becoming a key global player in the ‘internet of things.’ While the market has been slow to evaluate the impact of the newly established US$100bn Vision Fund, it represents additional optionality.
Opportunities across the market
Elsewhere, we have also found opportunities in financials, such as Sompo and Orix. The former, a relatively attractively valued Property & Casualty (P&C) insurer, has benefitted from an extraordinary improvement in pricing and claims conditions in the Japanese auto insurance market. At the time of purchase we believed it had the potential to release its substantial excess capital through the gradual unwinding of strategic equity holdings and stood out in value terms among its peers. The latter, a diversified financial, has had a strong track record of achieving excess return over time given its flexibility in allocation capital and reshuffling its business portfolio.
While many investors would characterise Japan as classic value, we have been successful at identifying exceptional value, corporate change and unique (growth) businesses. As we look around the world today, while the TOPIX has broken out of its trading range recently, Japan continues to represent an area of meaningful opportunity and we will certainly be on the lookout for new names that fit our investment philosophy.
The value of investments and the income from them can go down as well as up, so you may not get back what you invest. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. The Fidelity Global Special Situations Fund uses financial derivative instruments for investment purposes, which may expose it to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Changes in currency exchange rates may affect the value of an investment in overseas markets. Investments in small and emerging markets can also be more volatile than other more developed markets. Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities, but is included for the purposes of illustration only.