Overlooked way to play technology trends

In our latest Insider Interview, Miyako Urabe, manager of JPMorgan Japanese Ord (LSE:JFJ) Investment Trust, explains why digitalisation is a key theme. Urabe notes that in terms of technological advancements Japan is a “few years behind the West…but we are travelling in the same direction, just with a bit of a time lag”.

Urabe details the tech trends she's backing, and provides share examples. She also explains two key reasons why investors should consider having exposure to the region, outlines why defence is a new theme in the portfolio, and illustrates why it's important to have boots on the ground in Japan.

JPMorgan Japanese Investment Trust is one of ii’s Super 60 investment ideas. 

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Kyle Caldwell, funds and investment education editor at interactive investor: Hello, and welcome to our latest Insider Interview. I'm Kyle Caldwell, and today in the studio I have with me Miyako Urabe, manager of JPMorgan Japanese Investment Trust. Thank you for coming in today.

Miyako Urabe, manager of JPMorgan Japanese Investment Trust: Thank you, Kyle, for having me.

Kyle Caldwell: To kick off, could you outline your investment process and approach, and would you define your style as investing in quality growth companies?

Miyako Urabe: Sure, thank you, Kyle. So, JPMorgan Japanese Investment Trust is the largest Japan equity dedicated investment trust. It is investing in the very best ideas in Japan. It is bottom-up investments. We go across the market cap spectrum and there is a very clear growth and quality bias. So, the type of companies that we invest in will have higher return on equity, higher return on assets, operating margins. Stronger balance sheets, and good cash flow generation compared to other companies. And one other characteristic about us is that we have a large team of over 20 investment professionals located on the ground in Tokyo, which is quite rare for a foreign firm.

Kyle Caldwell: For those investors who are considering Japan as an investment destination, what would you say are the main attractions? What would be your elevator pitch to try and convince someone to invest in Japan?

Miyako Urabe: Sure. I think there are two key reasons to look at Japan. Now, the first and most important reason is corporate governance reforms. Now, we think that there's nothing short of a corporate governance revolution happening in Japan right now. The movement has been going on for a number of years now. So, it started around a decade or so ago when former Prime Minister Abe came into position. But I think that the movement had been accelerating, particularly over the past two to three years, after the Tokyo Stock Exchange announced their initiatives back in 2023.

Year by year, we are seeing a record amount of share buybacks being announced from corporates. Companies are announcing restructuring plans on their business portfolio to improve profitability. You see more TOBs (takeover offers), and MBOs (management buyouts). Companies are getting rid of parent-child listings, cross-shareholdings. And these are things that we just really didn't see until just a few years ago, and it's very new and exciting.

We believe that we are still at the relatively early stage of corporate governance reforms, particularly if you consider the fact that approximately 50% of non-financial Japanese companies have net cash balance sheets. There's much more we believe can be done.

The second point, I think, is getting out of deflation. Japan is an economy that's been in deflation for a very long period of time. Finally in the last two, three years, you are seeing inflation pick up. Now you really see it everywhere. For example, my grocery bills are going up. My son's drum lesson fees were recently hiked. Now it's a miracle that I can still get a proper lunch set for just £5 in the Chinese restaurant within our building. But actually even that restaurant has secretly drawn a price hike by keeping the price [static], but giving you fewer fried dumplings per plate.

So, you really see it all around, and more importantly, you're seeing wage hikes. Japan hasn't seen wage hikes for 20, 30 years, but in the last three years, you've seen an accelerated growth of wages. And this is really important, and it's a very big deal for us, and if it continues, it can be supportive for the domestic economy and for consumption.

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Kyle Caldwell: A key part of your investment process is understanding the risks of a business, and you have a survey of 98 risk-related questions. Of course, we haven't got time to go through them all right now, but could you give us a flavour of the sorts of questions that you ask?

Miyako Urabe: Sure, so the 98-question risk profile checklist is a list of questions that we answer for all of our coverage companies and we do it to assess possible risks to the business model. So, three-quarters of those questions are related to environmental, social and governance (ESG). So, that is where ESG is clearly embedded in our process.

Just to give a bit of a flavour [in terms of] what the questions are like, it can include questions around long-term profitability and sustainability of that, questions around the strength of the balance sheet and financing needs. It can include environment-related questions such as the impact from greenhouse gas emissions, or, for example, governance-related questions such as the independence and diversity of the board.

Kyle Caldwell: You have around 50 to 60 holdings. Could you outline the key sectors and key themes within the portfolio?

Miyako Urabe: Sure. So, just to give a few examples, first, digitalisation. Now, Japan is a few years behind the West when it comes to things like e-commerce, cloud software services, cash payments. But we are travelling in the same direction, just with a bit of a time lag. So, we invest in a number of IT service and software companies that can potentially benefit from the spread of digitalisation ahead. Also automation is a theme that we invest in. Japan has many companies which are pure plays on automation and global number one in their field.

So, for example, Keyence is global number one in factory automation sensors. They have very high profitability with operating margins north of 50%, a very strong balance sheet and net cash position.

Also, gaming and intellectual property is another area we invest in. Japan is home to many companies with very strong, globally competitive IP. If you just look around at the kind of things that your children are playing with, it can be Hello Kitty, it could be Super Mario, Pokémon, Monster Hunter, Street Fighter.

For example, Nintendo has very strong intellectual property, including Super Mario. They also recently announced their new hardware, Switch 2. It's gaining very strong demand and I've actually already failed twice to get a reservation on that.

Another theme is defence. This is a relatively new theme for us. It's an industry that is seeing a lot of change at the moment. So, historically defence is a low growth, low profitability area for us, but right now, Japan, similar to some other countries as well, is expanding their defence spend. So, this area of the market is suddenly shifting to a higher growth and also higher profitability area of the market. And it's very new and exciting.

On the other hand, as this is a best ideas approach, when we have low conviction on the longer-term growth outlook, we often just don't invest at all in that area. So, for example, autos is a very large part of the Japan index, but we have no exposure to US-exposed autos. Also, areas like railways, it's quite hard to find areas of growth there, so we own no railway companies.

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Kyle Caldwell: As part of the technology exposure that you outlined, how much exposure do you have to artificial intelligence (AI) or semiconductor firms? I understand these are key areas of focus for Japan's government, and they've pumped a lot of money into these sectors.

Miyako Urabe: Yes, so we are positive on the mid- to long-term outlook for the semiconductor industry. And also, the semiconductor supply chain is an area of strength for Japan. There are many Japanese companies in the supply chain that have global number one positions.

For example, one holding in the trust is called Advantest. They are a global leader in semiconductor testing equipment. They have market share globally north of 50%. It's a duopoly market with Teradyne, and conversations with our global teams indicate that Advantest has been increasingly gaining market share in recent years.

Trends such as high-performance computing products and greater chip intensity are trends that lead to higher intensity of testing and longer testing hours, which is positive for the mid- to long-term outlook of the industry.

Kyle Caldwell:And of the 50 to 60 holdings that you have, how often are you making changes to the fund and could you highlight a recent stock example that you bought?

Miyako Urabe: Absolutely. So, we are long-term investors, so the turnover of the portfolio tends to be pretty low, and there are many holdings in the trust that we have owned for well over a decade.

Now, on recent purchases, we initiated a position in a company called IHI last year. It's one of the top 10 holdings right now. This is a heavy industries conglomerate, but the story there is, number one, they are conducting restructuring, getting out of low-profitability businesses, kind of in line with the corporate governance revolutions that you're seeing in Japan, and they are focusing their resources on two core businesses, one which is aerospace engines, and [the other] which is defence.

On aerospace engines we think that that's an attractive business to invest in, it's quite a steady revenue supported by spare parts sales which carry higher margins and it's also a pretty high barrier of entry in that field. For defence, as I mentioned, the outlook for the industry is changing dramatically right now and we are very excited about the long-term outlook.

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Kyle Caldwell:You carry out a lot of face-to-face meetings. How important when investing in a region like Japan, is it having boots on the ground?

Miyako Urabe: We think it's very, very important to have a large local presence on the ground. I don't think I can emphasise this enough. I think the key point is that Japan, despite being the world's third-largest economy, has very poor sell-side coverage. Approximately 70% of the market has less than three sell-side analyst coverage, which is very poor compared to other regions like Europe or US.

So, we think it's crucial to have a large team on the ground and be able to conduct thorough research on our own. Now, we have over 20 investment professionals located on the ground in Tokyo, analysts and portfolio managers, and we conduct over 4,000 company meetings per annum. I think particularly in recent years under the corporate governance reforms, you're seeing a lot of changes at the corporate level, and at sector level, and I think it's very important to have a well-resourced team on the ground with long-term good relationship with corporates to be able to pick up those changes.

Kyle Caldwell: Miyako, thank you for coming in today.

Miyako Urabe: Thank you, Kyle.

Kyle Caldwell: That's it for our latest Insider Interview. Hope you've enjoyed it. Let us know what you think. You can comment, like, and do hit that subscribe button for future video interviews. Hopefully, I'll see you again next time.