Emma Wall: Hello, and welcome to the Morningstar series, Why Should I Invest With You? I'm Emma Wall, and here with me today is Andrew Rose, Manager of the Gold Rated Schroder Tokyo Fund.
Hello, Andrew.
Andrew Rose: Good morning.
Wall: So, if we were sitting here 12 months ago, I'd be asking you why the Japanese stock market had fared so brilliantly so far the year, however, it's a slightly different story in 2014. Japanese stock market is actually one of the worst performers so far this year. Why is this? What has changed?
Rose: Yes, I mean 12 months ago, the market was just about peaking. So the bulk of the Abenomics rally had taken place in the first five months of 2013. And since then it's rather mark time and then, as you say, sold off quite aggressively in early 2014.
I think there are a number of reasons. One was that coming into 2014, investors were fairly convinced that there might be more Bank of Japan easing and that hasn't happened. Secondly, there were worries about the consumption tax increase, the VAT increase, which took place in April. And thirdly, I think concern about the sort of third arrow of Abenomics, say, the supply side reform measure. So I think for those reasons, the market has been an underperformer.
Having said that, from about a month ago, we've had quite a strong rebound. So, at one point in February, the market was down 15% year-to-date, it's now down only about 2% year-to-date. And what's interesting is it, in contrast to 2013, the main buyers over the last months have not been foreign investors, they have been local investors, and the rise in the market has been accompanied by a slightly stronger yen, whereas last year weaker yen meant a stronger market. So, yes, it's be disappointing year-to-date, but some encouragement over the last month.
Wall: And one of the things that's happened in Japan is this introduction of a new index, the Nikkei 400. How has that impacted corporate governance and expected to in the future, because there are some rules about being included in this index, aren't there?
Rose: Yeah, I mean, most indices hinge on market capitalisation, so, Japan, the TOPIX Index or FTSE Index in U.K., for example. And where this index is different is that the weightings are determined more by company profitability, particularly ROEs, and it started in January; it's been for six months now.
And where it's sort of had a positive impact on corporate governance is that some well-known names, Japanese companies have not been included because they don't have the required level of profitability. And some of those companies, frankly, have taken umbrage at this; it's sort of a slight on corporate pride, if you like.
And you've seen instances where they've taken steps to improve ROE. So, there was a company last week, a couple weeks ago, which has quite high operating profitability, but a low ROE, because the cash on the balance sheet is too high. And they have said they're going to pay out that cash via a buyback or dividend increase.
So, it's an incentive to companies to boost their profitability and look after shareholders to a greater degree than it happened in the past, so that's definitely a step in the right direction.
Wall: And talking of shareholders, there's been two big consumer finance launches recently. There is this new pension and also Japanese investors can now invest in ISAs.
Rose: They can, they can.
Wall: And how is this going to impact the stock market and is it going to have an effect on both domestic investors and indeed international ones?
Rose: I mean ISA started in January and we've had them here for years and years, but Japan, they started in January, it's ¥1 million, it's about $10,000 per account each year. And so far to be fair, it's been a fairly muted impact. And I think the reason there has been that since it started in January, the market itself has been under pressure and not very exciting, and therefore you haven't seen a rush of moves into ISAs.
Also you've had the – actually, the tax authority have been quite slow in setting up the accounts. So, in terms of the sort of short-term supply and demand impact on the equity market so far is fairly muted. But for me the significance is actually longer term because it encourages a long-term buy and hold approach to equities, which has been very successful in most markets. But many individual investors in Japan haven't taken that approach. It's been more of a short-term trading.
So, to the extent it encourages a long-term buy and hold strategy, I think that would be significant. And also significant in the sense that compared to other markets, Japanese individual investor exposure to equities is quite low, below 10% and that made sense when you had deflation. But if Abenomics works and you get inflation, that doesn't makes sense.
So, as a way of sort of encouraging a move more out of cash deposits into equities, I think it's significant as well.
Wall: It's something that we have seen in the U.K.; isn't it, the whole great rotation, and you’re saying that perhaps Japanese investors similarly to British investors aren't very good at being contrarian. So, there needs to be an uptick in the market before you think this will start to have an effect?
Rose: Possibly. There is certainly one side there. You could argue actually that sitting with lots of money in the bank when you had deflation was actually a very sensible logical thing to do because the real interest rates were positive. But Abenomics targeting inflation real interest rates will be negative, it doesn't make sense. So the sort of economic incentive or logic to move into equities is definitely there and ISA would be one way of encouraging that.
Wall: Andrew, thank you very much.
Rose: No problem. Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
