Ernst Glanzmann, head of Japan equities at GAM, explains why he believes only old-fashioned, bottom-up, long-term investing leads to sustainable outperformance.
Japan offers plenty of opportunities for equity investors: Its companies are world-class in the areas that will define the world of tomorrow, including precision manufacturing, factory automation, assisted driving and robotics.
But instead of focusing on great companies, many investors fall into the trap of trying to time the market and playing the currency.
One has to admit: Japan has certainly not made things easy for investors. The Topix index is still trading substantially below its all-time peak, while the economy has produced its fair share of negative news for as long as most people can remember.
However, this top-down view can obscure opportunities from investors. The broad stock market index is lumbered with companies that are indeed held back by the adverse macroeconomic backdrop of low growth and stubborn deflation. Quite a few of them have failed to adapt and are inefficiently managed, but there are exceptions. Luckily, for us as investors this means that the case for active stock selection is much more obvious in Japan, as is the scope to add value.
Only invest in the best
Rigorous fundamental analysis of the stock market universe is key. The approach that has served us well is to only invest in the very best businesses. First, these companies need to have excellent management teams in place that have proven outstanding entrepreneurial achievements. As long as these true leaders deliver and their relative valuation remains attractive, there is no valid reason to ever sell them. Typically, the names show long-term earnings growth, which in turn drives their stock price upwards. Firms of that calibre, of which there are not very many around, also tend to prove resilient during market weakness.
Our experience and track record shows that this approach – investing in high-quality companies, yielding superior performance across business cycles – also removes the incentive for market timing, which is tricky at the best of times. It looks of course tempting: every time the yen weakens substantially, Japanese indices rally driven by the major exporters. The Bank of Japan’s various phases of quantitative easing over the past few years come to mind. They have led to a weaker currency, in turn boosting share prices.
To us, this is a common error in perception because the yen’s depreciation reduces the value of one’s investment when translated into the portfolio currency, offsetting some of the share price gains in yen terms. The same is true vice versa. For example, the yen’s appreciation since January of this year was a contributor to the Topix’s weakness year-to-date (to 31 May). But the Topix’s decline in US dollar terms was less than one-third of the drop in yen terms.
Foreign investors benefit from lower volatility
This built-in hedging characteristic has a number of benefits. First, it means that the additional cost of actual currency hedging can be saved if the investment horizon goes beyond a few months. Second, the effect also dampens volatility for foreign investors. For example, over the past five years, the annualised standard deviation of the Topix was 13.7 in US dollar terms, but 17.9 in yen terms (to 31 May 2016).
Hence, international investors should look at equity market returns in their local currency, such as euros and US dollars. The final point relates to corporate earnings and is critical for any bottom-up investor: Net earnings growth of high-quality Japanese companies translated into foreign currency are on a comparable level to those of their major developed market peers – and often they are actually higher. Over the long term, this should be reflected in share prices.
Ernst Glanzmann, head of Japan equities at GAM