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Searching for a dancer in a crowded arena

March 2023 Newsletter

Searching for a dancer in a crowded arena

We use a bottom-up approach for security selection at Ballina Capital. When we construct portfolios, we aim to maximize return and diversification, while we limit volatility. We do this without country or sector limits. Our process does happen to bring us a wealth of opportunities in Japan, and this is holding true in 2023. It makes us puzzled when we see the holdings data of many international equity funds, especially Value funds, that do not seem to share our substantial interest in Japan. In fact, one can’t help but get the impression that International equity investors based in North America or Europe must be very skeptical about Japan. And the data confirms this. We analyzed the category averages from Morningstar[1], and the relevant fund categories are meaningfully Underweight Japan. See below. We wanted to use this newsletter to explore the market concerns about Japan, and then mention where we find attractive Japanese assets. First, we will explore what many investors say when they are asked why they are negative on Japanese equities.

International and Global Funds are Underweight Japan

Typical reasons mentioned for being bearish on Japan:

Weak Corporate Governance – Corporate Governance is a catch all phrase for the rules and practices of how a company operates, and how this aligns with the interests of stakeholders. Shareholders are important stakeholders. Japan has been highlighted as having weak corporate governance for a very long time, and shareholders rewarded this reputation with weak stock market performance. Many of the other justifications for avoiding investing in Japan listed in this newsletter, for example – cross shareholdings, are a consequence of poor Corporate Governance. Japan’s Government recognized this reputation, and more importantly, recognized the link between Governance and private sector investment, R&D investment, corporate creativity and business formation. To drive improvement in the latter, the Government introduced the Japanese Corporate Governance Code (“JCGC”) in 2015, and this has been subsequently tied to listing requirements. The poor Governance reputation remains for most market participants, and we have to remember that if the Government had to write a code so that most corporates could be held to account for doing the right thing, progress on undoing the reputation is probably going to be slow.

Cross Shareholdings – Cross shareholdings refers to the practice whereby Japanese companies tend to have friendly companies own shares in the company, and often return the favor by doing the same for their corporate friend. What you end up with is a patchwork of ownership across the corporate sector, and the end effect is that activism, corporate governance and balance sheet efficiency are undermined. While many Japanese companies have been unwinding the cross shareholdings, 1/3 of Japan’s stock market is still owned by cross shareholders. That is down by 50% since the 1990’s[2]. While headed in the right direction, the level of cross shareholdings is still an anomaly on the global investment landscape.

It should be noted that the Japanese Corporate Governance Code, in place since 2015, and edited a few times since, specifically addresses Cross Shareholdings: “When companies hold shares of other listed companies as cross-shareholdings2, they should disclose their policy with respect to doing so, including their policies regarding the reduction of cross-shareholdings. In addition, the board should annually assess whether or not to hold each individual cross-shareholding, specifically examining whether the purpose is appropriate and whether the benefits and risks from each holding cover the company’s cost of capital. The results of this assessment should be disclosed. Companies should establish and disclose specific standards with respect to the voting rights as to their cross-shareholdings, and vote in accordance with the standards.”

Investors still remember the Post bubble Equity Market drawdown from 1989-1997 – some reference that investors that experienced the massive Japanese equity market meltdown post the Bubble period just cannot bring themselves to invest meaningfully in Japan. This would hold up as a justification if Japan did not post good performance over any recent period. However, Japanese equities have had very solid comparable performance over the last ten years. See below. The numbers have become weaker in the more recent years, specifically the one, three and five year periods where the returns have been more correlated with other Asian markets. It appears that investors are punishing Asian markets where corporates may find it more challenging under a more polarized world of de-globalization. Nonetheless, over a ten year period Japan has been an outperformer among International equity markets. If we keep in mind that many Portfolio Managers are 55 years of age or older, yes, it is very realistic to assume that they have deep seated biases against Japanese equities. In the formative years of their career, there were very few reasons to be positive, and most Japanese shares performed very poorly.

Corporate Returns are Too Low – Corporate returns on capital or equity matter because there is a strong correlation between stock market returns and corporate returns. Compared to most developed markets, yes, Japanese corporate returns are low. See below. The good news is that there is considerable room for improvement, and indeed, Japanese returns have been moving up. Another important piece to notice is that Japanese corporates tend to have latent balance sheet capacity, given low debt levels. (See debt/equity below). This would bring extra capacity for returns, especially in a period of rising interest rates, relative to markets where corporates use much more financial leverage (for example Spain, see below). Principle 1.3 of the JCGC requires a “basic strategy with respect to capital policy”, and most companies meet this requirement by issuing a Return on Equity target. We can therefore assume that lack of progress on ROE in Japan is not due to lack of a goal.

The Japanese Central Bank buying Equity ETF’s brings too much risk – a surprise to some is that the Japanese Central Bank, as part of their Quantitative easing efforts, bought domestic equity ETF’s for more than a decade. See below. They stopped buying during 2021. The holdings have accounted for as much as 77% of the domestic equity ETF market (source: Financial Times). Altogether, this portfolio (at 3/31/22, roughly 36 trn Yen worth), is equivalent to about 4% of the market capitalization of Japanese listed equities. The fear narrative goes like this, what if they decide to sell? It does seem kind of irrational to think that they would start unloading massive amounts of equity ETF’s overnight, but the Japanese Central Bank is a bit unorthodox, so selling on a smaller scale could probably commence at any time. Or, more likely, they will just hold what they have for decades.

Source: Bloomberg

Demographics – Populations are getting older across the world. The pace of aging differs. See below. Japan has, for some time, had the title of having the oldest population, with roughly 1/3 of the population over the age of 65 (source: World Economic Forum). The negatives of this aging demographic for an equity market investor are that : a) the working age population gets squeezed with more taxes, b) healthcare costs rise, and c) capital flows away towards younger populations, and GDP growth slows. What we can say about Japan is that they are used to operating with an older population. And in the coming decades, they will basically be joined by others. As you can see below, by 2060, South Korea will be older than Japan, and Spain and Poland will have roughly as many Seniors as Japan. For Ballina, Japan’s demographics are a very well understood dynamic factored into equity prices.

Expensive Market – this one is interesting because it is hard to find evidence anymore. Japan “was” an expensive market for many years. The NTM P/E for Japan from the 1990’s through 2007 struggled to reach a level below 15x. See below. In the non-crisis period since, the valuation on this metric has struggled to move above 15x for any meaningful period of time. This devaluation occurred even though, for a domestic investor, there was a stronger price and yield incentive to own shares than existed in other markets. JGB yields have been the lowest of all major markets for many years, and dividend yields of equities have been comfortably higher than those of JGB’s since 2015 (see 2nd chart below). In the third table below, we can see current valuations for Japan relative to other Developed Markets, and on Price to Tangible Book Value Japan is the cheapest of them all by a good margin, while the Price to earnings is lower than all but two countries in the group. Japan is not expensive anymore.

source: Factset

source: Factset

Other reasons that we will not expand upon:

Japanese investors do not like their home equity market

Low domestic economic growth


Export Dependence

Investor Relations

Proximity to better growth in rest of Asia

We liken the selection of Japanese value stocks to approaching an Arena full of 20,000 young people with the hopes of finding a good dancer. You might find an exceptional dancer. But it is unlikely that every person you meet, or certainly the first few, will be even decent at dancing. The search will require time. Whereas when we look at European equities, the best example being France, we find that it is a bit more like approaching a small professional dance studio. Virtually everyone present is a qualified choice. But it doesn’t mean that the arena full of young people doesn’t have better dancers! You must look, analyze, consider and deliberate. The arena analogy is especially relevant for Japanese small cap stocks. There are many of them! And International equity investors seem to better recognize the value of these Japanese small caps, as the Foreign Small-Mid Blend funds are actually Overweight in comparison to relevant benchmarks (source: Morningstar) . See below.

One stock we like in Japan is Video Gaming software company Gungho Online Entertainment (ticker 3765). Gungho has a Market Capitalization of roughly $1.7b USD equivalent. One factor that you notice with Gungho is the high historical returns. The five year average ROE for Gungho is 20.8% (source Factset). Gungho’s Financial Year concludes in December, and this means that the AGM takes place in late March. This is important in Japan because most corporates have their fiscal year end in March, and consequently are able to schedule their AGM on the same day(s) in late June so as to make it harder for shareholders to attend and express dissatisfaction. This is not the case for Gungho. Gungho has nine members of the Board of Directors, and three of them are Independent. They are proposing an additional independent tenth member of the Board at this year’s AGM, and this will be the first female member of the board. Gungho has been active repurchasing shares, a welcome sign for returns to shareholders, and recently disclosed that it had bought 485,500 shares in February of 2023. Gungho does not have any cross shareholdings. The aforementioned are a component of why we like Gungho. In addition we like their strong balance sheet and cash flows, product momentum and discounted valuation.

We also have a positive view of Tosoh Corp (ticker 4042). Tosoh Corp is a chemical manufacturer with a Market Capitalization of roughly $4.3bn USD equivalent. Tosoh makes many different chemicals including caustic soda, vinyl chloride monomer, bromine and flame retardants. Tosoh has averaged an ROE of 14.4% over the past five years. They have also increased returns to shareholders by increasing dividends at a five year CAGR of 10.8% (source: Factset). Tosoh does own shares in other Japanese companies, but they have been selling, and overall these cross shareholdings represent less than 5% of Tosoh assets. Four of the nine members of the Board are Independent, and one of them is female. We like Tosoh for a number of reasons, but especially have confidence that they can raise margins after a period that they were diminished by the raw material cost surge. We also like the strong balance sheet and cash flows.

Finally, we like Ryohin Keikaku (ticker 7453), Market Capitalization of roughly $2.9bn USD equivalent. This is the company behind the “Muji” Japanese home good retail concept. Muji sells everything from aroma diffusers, luggage, personal care products, and notebooks, and much more and all of these products are known for their functional design. Tosoh’s median ROE from the past five years is 17.2% (source Factset). Ryohin Keikaku has a financial year ending in August, so it is easy for shareholders to attend the AGM. Ryohin has eight members of the Board of Directors, with five of them being Independent, and three of them being females. We like Ryohin for the recovery potential after being a very poor performing stock over the previous five years. The company has plenty of room to move margins higher and trades at a discounted valuation.

We’re not aiming to suggest that the aforementioned Japanese companies are pillars of Corporate Governance. We just wanted to highlight components of why we believe these companies are capable of being good for shareholders. We did not get to dive into valuation, but each of the three companies trade at cheap valuation multiples relative to global peers, and relative to their own historical valuation. We mused earlier that looking for Japanese value stocks can be like searching for a talented dancer in a full arena. In the table above, notice that: a) Japan has easily the largest number of investable companies, and b) a large number of them are not covered (as reflected by the lack of an earnings estimate). More of the Japanese companies are uncovered, than exist in Australia or the UK. The large number of relatively small poorly covered companies makes it a rich hunting ground for a confident global investor.

Of course, poor Corporate Governance is a contributing factor in why there remain so many listed companies in Japan. We aim to make each investment case its own. Japan’s large roster of companies also allows one to be judicial about sector. For example, we can find cheap Health Technology and Technology Services companies in Japan, when most International markets have premium priced companies in these sectors. We’re not really sure why many of our peers avoid Japan. We believe that many of the risks are well known, and in many respects the companies are much more transparent and aligned with shareholders than they have been in the past. The budding banking crisis in the West in our view can provide relatively more support for Japanese equities. Japanese companies are capable of being mismanaged, but Japanese Boards are more typically leaving the balance sheet positioned for the 100 year flood. The stocks we have invested in could easily be dead money, but there is considerable untapped potential. We’re willing to be patient, within reason, for some of our selected dance partners.

Strategy Performance

International All Cap Value returned 1.48% on a gross basis, and 1.40% on a net basis, in March 2023 versus 2.84% for the benchmark. Year to date performance was 6.76% on a gross basis, and 6.49% on a net basis, versus 6.99% for the benchmark.

International Small Cap Value[3] returned 0.27% on a gross basis, and 0.19% on a net basis, in March 2023 versus 0.87% for the benchmark. Year to date performance was 6.16% on a gross basis, and 5.90% on a net basis, versus 6.25% for the benchmark.

Top Contributors and Detractors

International All Cap Value’s top contributor in March was AGL Energy Limited. The Australian utility was strong as some sellside and buyside firms were public in their view that the shares were undervalued. In addition, it was disclosed that the new AGL CEO has recently purchased shares. The strategy’s top detractor was Swedbank. The Scandinavian bank was punished in the wake of the collapse of Silicon Valley Bank and Credit Suisse in March. The negative view is that Swedbank is one of many global banks with Commercial Property loans that will suffer as credit tightens to the sector.

International Small Cap Value’s top contributor in March was AGL Energy. As mentioned above, there has been some market talk that the stock’s weakness was overdone, and the CEO buying shares supported this narrative. The strategy’s top detractor was Yanlord Land, a Singapore listed property developer with a large weight of operations in China. Financial conditions tightened significantly during the month, and property developers are negatively affected when credit access is harder to come by.


The opinions expressed herein are those of Ballina and are subject to change without notice. Past performance is not a guarantee or indicator of future results. Returns are presented gross and net of fees and include the reinvestment of income. The benchmarks being shown for comparison purposes are: a) for International All Cap Value - the Vanguard Total International Stock ETF (VXUS), and b) for International Small Cap Value - Vanguard FTSE All-World ex-US Small-Cap ETF (VSS). The information contained herein is not investment advice. The information contained in this commentary represents the opinion of Ballina Capital and should not be construed as personalized or individualized investment advice. You should not consider the information and commentary published herein as a recommendation to buy or sell any particular security. The securities identified and described do not represent all the securities purchased, sold or recommended for client accounts. You should not assume that any of the securities discussed in the commentary published herein are or will be purchased for your account, or are or will be profitable, or that recommendations we make in the future will be profitable or equal the performance of the securities listed in commentary. Consider the investment objectives, risks, and expenses before investing.

For the Top and Bottom Contributors: Contribution reflects the impact of performance and the portfolio weight to total portfolio return. Data show is from a representative account of the International All Cap Value and International Small Cap Value Composites. All returns are Gross of Fees. Timing differences of purchases and sales may have a modest impact on the actual contribution numbers presented. The calculation methodology along with detail on all holding’s contribution to the overall accounts performance during the measurement period are available upon request.

[1] Morningstar categorizes mutual funds on their platform. We reviewed the category average fund holdings for Japan and compared this to the International equity ETF’s with a large market following. [2] Nomura Institute of Capital Markets Research (2021). [3] On October 17, 2022, the Global Small Cap Value strategy transitioned to the International Small Cap Value strategy. From this date forward the focus of the strategy will be on International Small Cap stocks. The benchmark changed on 10/17/22 to Vanguard International FTSE All-World ex-US Small-Cap ETF (VSS).

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