One policy that stands out is the modernising of government apparatus through the digitalisation of the public sector. Radical changes in government infrastructure usually elicit strong opposition, but the Covid-19 crisis provided cover for an overhaul of the current system.
The digitalisation drive is also creating opportunities in the private sector, as the pandemic highlights the need for companies to enhance their digital capabilities after years of underinvestment in information technology infrastructure.
Runway of growth
The Fidelity Japan Trust is exposed to this theme through holdings in ‘software as a service’ companies and efficiency enablers in the mid-small-cap space that have a decent runway of growth and are not well owned by other investors.
Looking ahead, Suga’s commitment to reduce overall greenhouse gas emissions to zero by 2050 has the potential to create new investment opportunities in areas such as renewable energy and infrastructure spending.
Now vaccinations have begun, downside risks should gradually reduce downside risks and, against this backdrop, there has been a swell of news around the Tokyo Olympics. Prime minister Suga and Tokyo governor Yuriko Koike are adamant the games will go ahead – a view that contrasts sharply with that of the general population.
In any event, corporate earnings in Japan will continue to recover as the global economy normalises in 2021. In addition, prioritising measures to control the pandemic would be far more positive for share prices than going ahead with the games and running the risk of further outbreaks.
Companies and sectors to watch
Even amid the pandemic, we saw a lot of micro-level activity in 2020. The initial public offering (IPO) environment picked up in the second half of the year, with more than 90 companies coming to market during the 12-month period. This represented a modest uptick from 2019 and is in line with the average over the past five years.
Being on the ground means we see a lot of these new ideas and business models first-hand, and continually meeting with pre-IPO companies enables us to identify the most attractive opportunities.
At the end of the review period, the trust held three unlisted securities. We will continue to look for early-stage ideas and nascent disruptors, particularly among fast-growing services and internet-based companies, as well as innovative names in medical technology.
There was also a significant amount of takeover bids and mergers and acquisitions during 2020, especially in terms of companies buying in their listed subsidiaries.
Market reforms by the Tokyo Stock Exchange and enhancements to the Corporate Governance Code should drive further consolidation in 2021. There are opportunities to invest in companies, particularly conglomerates and industrials, where business reorganisation could drive a re-rating – or at least act as a share price catalyst.
Japan’s Ministry of Economy Trade & Industry and the Financial Services Agency enacted a number of measures aimed at enhancing environmental, social and governance (ESG)-related factors, promoting effective engagement and stewardship, as well as encouraging companies to undertake business restructuring including spin-offs.
As a member of the Council of Experts, Fidelity provided views on various stewardship-related issues and contributed to the drafting of new revisions.
Changes to the Corporate Governance Code in 2021 will aim to increase the number and quality of outside directors, improve capital efficiency through the elimination of cross shareholdings and enhance group-level governance through the dissolution of parent-subsidiary listings.
Stock market reforms slated for 2022 will also challenge companies to improve governance, consolidate non core businesses and unwind strategic shareholdings.
Going into 2021, the portfolio had a relatively large technology tilt, with a focus on globally competitive companies with strong balance sheets, reasonable valuations and a secular growth story.
While I took profits in some of the more cyclical technology stocks and naturally trimmed the winners, the overweight exposure to the sector remains in place. Key holdings include component makers Murata Manufacturing and TDK, both of which are beneficiaries of rising smartphone and automobile shipments, and increased content per unit. I focused on domestic services stocks that are well positioned to recover and grow their businesses as restrictions are lifted. Companies in the internet services, e-commerce and educational software sectors that can benefit from changes in the way we work, shop and play were of particular interest.
There is likely to be a longer-term impact on how companies do business together, and how their processes can become more resilient through, for example, the use of online and cloud computing.
See also: Robotics and automation investment opportunities abound in Japan – Stefan Rheinwald of Waverton Investment Management sees financial and profitability metrics over the long-term.
Japanese companies have generally been laggards in terms of building that resilience, and the Covid-19 crisis is highlighting the need for them to enhance their digital capabilities. Companies that can supply some of the services to facilitate corporate Japan’s digital transformation offer attractive growth opportunities.
I have also been looking closely at company balance sheets and survivability, and reduced some of the financially leveraged names in the fund and some of the winners in 2019 that were liable to profit-taking. I have also avoided companies that had a onetime boost in coronavirus related demand, or where I thought a recovery would be severely delayed.
Overall, I am cautiously optimistic on the investment outlook for Japanese stocks in 2021. The pandemic clearly poses near-term risks, as new variants of the virus and rising infection rates across the globe push governments to reimpose or extend restrictions.
However, the gradual rollout of vaccines and continued monetary and fiscal policy stimulus are positive for the global growth outlook, and will be supportive of Japanese equities. Against this backdrop, I expect the market to be in an earnings- driven phase, with positive earnings surprises driving individual stocks rather than multiple expansion as we saw in 2020.
A number of themes present themselves. Clean energy and environmental efficiency are areas where apan has some very competitive companies that can supply solutions to the regulatory and productivity needs of customers globally. This is a core part of the portfolio and I epect related names do well for the trust going forward.
Covid-19 has also accelerated trends in e-commerce and digitalisation. As profits recover, companies will prioritise those areas. More ethical consumption is also likely to be important in business to consumer-facing companies.
I am also widening the net and looking for companies with recovery potential in areas such as leisure and travel. As we start to see better earnings announcements in fiscal 2021, there will be an opportunity to pick up companies that are changing into – or returning as – growth names.