‘Very attractive’ outlook for country Warren Buffett backs

Miyako Urabe, manager of JPMorgan Japanese Ord (LSE:JFJ) Investment Trust, outlines the reasons for optimism for investing in Japan, a region that Warren Buffett's fond of. In his recent annual letter to shareholders, Buffett committed to his firm’s Japanese investments for the long term.

Urabe cites cheap valuations and corporate governance reforms, which are making companies more shareholder-friendly, as reasons to be bullish over the long term.

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: You focus on company fundamentals, you're a stock picker. How does the wider macroeconomic environment fit into your investment decision-making?

Miyako Urabe: So, we are bottom-up stock pickers, and we have an investment process, and we follow it. What we do not do is move around and try to change the style top-down based on what's happening at a macro level. But obviously we are very aware of what's happening in the macro environment. We discuss it all the time within the team, and particularly when there are changes in macro that can affect the earnings outlook for corporates on a mid-long-term view. We pay very close attention.

For example, one of the top holdings in the trust is called Rakuten Bank. It's a digital bank and a disruptor in the industry. It's very different from any other traditional bank. We like the business. It sits within the Rakuten Group ecosystem. Now, what Rakuten Group have is one of the largest e-commerce platforms in Japan, so kind of like Amazon. And the strength of Rakuten bank is that they can leverage the very wide user base of the Rakuten Group to increase its assets. So, it's an attractive business, good growth, high profitability, but also it actually happens to be very rate sensitive and it's highly sensitive to a rise in domestic rates. So, it does benefit from that change in macro environment.

Kyle Caldwell: A key trend within Japan for a number of years now has been the ongoing corporate governance reforms. Could you talk through what these reforms are aiming to achieve? And is it having the desired effect of increasing money going into Japan, particularly from international investors?

Miyako Urabe: I think the response from international investors were initially a bit more sceptical. Japan's been talking about corporate governance reforms for quite a few years, but we hadn't seen an acceleration; is this time really different?

But I think that the turning point came two years ago in 2023 when the Tokyo Stock Exchange announced their initiatives, telling companies with valuations of price to book ratio below one times that they should do something about it. Since then, we have really seen an acceleration. I mean, [because we're] speaking to companies every day, and on the ground, we really feel the change in mindset.

And we've seen, year after year, record levels of share buybacks announced, and companies are announcing restructuring plans in their business portfolios to enhance profitability. We are seeing an increase in management buyouts and tender offers. Private equity firms coming in, even hostile takeovers being announced, and this is very new. We really hadn't seen these trends up until just a few years ago, and it's really new and exciting.

We believe that there is still much more to go, particularly considering the fact that 50% of non-financial Japanese companies have net cash balance sheets. There's certainly more that they can do. I think, gradually, the story of corporate governance reforms is being accepted by international investors, but we believe that the Japan equity market is still under-invested and under-owned.

Foreign investors turned net buyers of Japan from the early part of 2023, but if you look at the aggregate buying level, it's still very far below the peak that you saw most recently around the Abenomics era. So, despite all these positive developments, I think Japan is still under-owned. Also, if you look at valuations as well, it's still not demanding, both compared to its own history and also versus other major markets.

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Kyle Caldwell: As well as increasing levels of share buybacks that you've mentioned, companies are also becoming more dividend friendly. As you're a growth investor, how does that impact your investment process?

Miyako Urabe: We're seeing a very positive impact on our portfolio, too. I think because the Tokyo Stock Exchange initially said the words, stocks with price-to-book ratio below one times, there was a bit of a perception that maybe this corporate governance reform will be particularly focused on value stocks. But that's certainly not the case, and you are seeing corporate governance improvements across the market cap spectrum - growth, quality, all sectors, you're seeing it very broad-based.

Kyle Caldwell: And from a valuation standpoint, how does Japan's stock market compare today versus its history? Is now potentially a cheap entry point to gain exposure to Japan?

Miyako Urabe: So, despite all the positive developments that I've been discussing, if you look at the valuations of the Japan equity market, it's still not demanding both compared to its own history and also versus other major markets.

So, if you consider the fact that all these corporate governance reforms that are taking place can potentially lead to an improvement and return on equity levels in future, and the lower return on equity (ROE) of Japan has been one of the key reasons for the valuation discount versus other major markets historically, I think that the outlook for Japan is very, very attractive.

Kyle Caldwell: For UK investors venturing overseas, something that they have to bear in mind is potential currency risk. We've seen over the past five years that the yen has depreciated around a third against the UK pound. Do you look to mitigate against currency risk?

Miyako Urabe: Sure. So, yes, as you say, the yen has significantly weakened over the past few years. I think the key reason behind that is interest rate differentials. While other major markets were increasing the interest rate on the back of inflation, in recent years, the Bank of Japan kept its very loose monetary policy.

The situation has changed more recently. If you look from last year, the Federal Reserve, or the US, has stopped hiking rates and has moved to rate cuts, whereas in Japan, the Bank of Japan is moving towards gradually normalising its very loose monetary policy.

It's very difficult to predict short-term movements on forex, but I think there is limited reason to think that the yen could significantly weaken beyond recent peaks.

Now, for the portfolio. First of all, we haven't hedged the currency. On the FX exposure of the portfolio, it is basically neutral versus the benchmark. Movements either way we would not expect to significantly impact relative performance. Now that's really just a result of the fact that we find a lot of attractive ideas both in exporters and in domestic names.

When I say exporters, I think a lot people think autos. But in our case, we are very underweight autos. The kind of exporters that we hold in the portfolio are things like global number one factory automation companies, or global number one semiconductor supply chain names, globally competitive gaming and intellectual property companies.

But equally, we find a lot of attractive ideas in domestic sectors. For example, Japan is years behind the West when it comes to things like cloud software services, cashless payments, e-commerce. So, we invest in IT service and software companies that can potentially benefit from that expanding trend.

Kyle Caldwell: In terms of performance, how has the investment trust fared over the long term? Say, on a 10-year view, has the investment trust outperformed the wider Japan market?

Miyako Urabe: Looking at the past 10-year performance, the net asset value for the trust rose by 127%. Over that same period, the TOPIX grew by 103%. We have outperformed TOPIX and we are the best-performing Japanese equity dedicated trust in the sector. The share price performance similarly outperformed during that period.

Kyle Caldwell: The net asset value return, which is the performance of the underlying investments, that's what you're in control of as a fund manager, whereas shareholders, they'll actually get the shareholder total return, which can be influenced by other factors as well.

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Miyako Urabe: Sure. So, on the valuation discount or the NAV discount of the trust, the board is very aware of the NAV discount and has been proactively conducting share buybacks in recent years.

I think the current NAV discount is not out of line with what is happening in the broader investment trust sector and in fact I think it is actually notably tighter compared to other investment trusts. I believe perhaps that is a reflection of the relatively good recent performance, as well as the bigger size and liquidity, particularly after the merger with JPMorgan Japan Small Cap Growth and Income last year.

Kyle Caldwell: Investment trusts have the ability to gear or borrow to invest. What are the current gearing levels on the investment trust and how do they compare with the typical range?

Miyako Urabe: The current gearing of the trust is around 11%. This is a reflection of our very constructive view on the Japan equity market outlook, and also our confidence in the companies that we're investing in. So, really a reflection of the confidence in our stock selection. Now, if you look at what's happening in Japan with the corporate governance reforms, you're seeing more companies changing, companies that we may not have seriously looked at few years ago suddenly turn around and announce restructuring, changes in capital allocation and moving on a path towards quality. We think the opportunity set is only increasing in Japan.

Kyle Caldwell: Finally, a question we ask all fund managers we interview, do you have skin in the game?

Miyako Urabe: Both of the managers of the trust, Nicholas Weindling and myself, are invested in the trust. We are very happy to be able to have direct exposure to a portfolio which we believe is the best way to run our clients' money.

So again, we are very positive on the outlook of Japan backed by the corporate governance reforms and an exit out of a long period of deflation, and we're very confident in the companies that we're investing in.

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.