This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, Tim Gregory head of Global Equities for Psigma, discusses how a new index is impacting corporate governance in Japanese companies.
It is inevitable that global asset allocators usually focus their attention on the macroeconomic environment of a given country when formulating their global equity strategy. For instance, there is an apparent obsession with Chinese GDP data and whether it will be higher or lower than the 2014 growth target of 7.5% that the government has set. This obsession may continue regardless of how relevant this may or may not be on ones’ decision to invest.
A similar obsession is occurring in Japan. The recent hike in the sales tax, impatience over the impact of Abenomics and the policies of the Bank of Japan, have all become a stick to beat up the Japanese stock market with, making it one of the worst performing markets this year. However, this noise potentially ignores a material change in the “bottom up” fundamentals of the Japanese stock market.
The determination of companies to try to gain entry into the Nikkei 400, a new index launched last summer which only accommodates shareholder friendly companies with the highest three year return on equity, is leading to a change in management behaviour of even the most traditional companies.
Take Amada (6113) for example, an old fashioned manufacturing company who for many years made little or no effort to improve returns to shareholders, that is until it was excluded from the new Nikkei 400 Index. Since its exclusion, Amada has announced that it will return half of its profits in dividends and pledged to allocate the rest of its free cash to share buybacks.
There has been a lot of speculation that the Japanese State pension fund, the Government Pension Investment Fund (GPIF), has been actively buying equities, absorbing the foreign selling of stock that was presumably accumulated when Japan was running hot last year. If the GPIF is focusing its attention on the companies in the Nikkei 400, then clearly Amada’s recent behaviour is likely to become common practice amongst companies – Amada’s share price has risen nearly 50% since its announcement, which ought to be sufficient inspiration to other corporates to follow suit.
Why wouldn’t the GPIF buy the stocks of companies committed to returning money to investors when Japanese 10-year government bonds yield a meagre 0.6%? This has been a very powerful driver of US stock performance in recent years and with Japanese equities offering a yield of around 2% on just over 11 times earnings, this could potentially help drive the powerful rerating of the Japanese market that we still strongly believe is possible in the coming years.
In fact, Japanese macro data may not be as bad as the Bears fear. Indeed first quarter GDP data was actually revised to a higher level than originally announced, driven not by a pull forward in consumer spending but by an increase in business investment.
In recent weeks Japan has recovered more than half of this year’s hefty losses and while we expect a continued and gradual improvement in Japan’s economic performance, we believe that the behaviour of corporate management towards shareholders will become far more important to investors, rather than the obsession over the decimal points of short-term inflation data and GDP growth.
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