Customer Centric Values for Asset Management

In February 2024, the Nikkei 225 roared past the JPY 40,000 mark, and this has been a record-breaking year for Japan, financially speaking. We also saw increased IPO activity, with 97 companies going public, raising over JPY 570 billion. There has also been a surge in private equity deal-making, with the average number of deals tripling from 2018 to 2022. This has all drawn unprecedented levels of foreign capital into Japan’s financial markets, with foreign investments at a ten-year high. What do you believe are the core reasons for this extraordinary performance in Japan’s investment markets?

Japan has been undervalued for the past few decades, and it needs to be recognized by global analysts that Japanese companies have been worked to improve capital efficiency during this period. Japan, with time, has taken active steps in the betterment of corporate governance to increase capital efficiency. This has laid the foundation for Japanese companies to grow. The JPY depreciation has also further pushed the opening of the Japanese market, leading to positive company turnovers and allowing Japan to escape deflation. It is true that there is a macro element that is pushing Japan to inflation, but at the same time, internal pushes such as wages have created a positive inflation cycle overall. Backed by foreign exchange hedge gains based on interest rate differentials, foreign money starts pouring into the Japanese market, and this has continually expanded. The profitability of Japanese company has greatly increased, but the stock price is still undervalued compared to other markets. This positive situation will continue to gain momentum.

With the rise of interest rates in Japan, foreigners may view it as an obstacle to further foreign investment in Japan, but if you look at it from a domestic perspective, the abnormally low interest rate has actually hindered Japanese companies from growing. By normalizing the interest rate, the situation has switched to become more favorable for Japanese companies. This low interest rate has created a situation of excessive low-price competition that prolonged the lives of many unprofitable companies and did not even generate the profits to raise wages. As a result of the normalization of interest rates and the reintroduction of healthy competition, only those companies that can generate adequate profits are now in a position to survive.

This situation will also result in more positive consumption. The reasons why Japanese households reserved more than 50% of their assets in cash and deposits despite the fact that they do not generate interest income are that the relative value of cash and deposits had increased due to deflation and the lack of expectations for economic growth based on a deflationary mindset. In Japan, households are the main savers, and the government is the main borrower. While abnormally low interest rates deprived households of interest income, the government's burden of interest payments on government bonds was suppressed, and it was the government that benefited the most from low interest rates. Interest income from the elderly, who have large cash deposits, will go to consumption; the generation under 50 has experienced a substantial wage increase for the first time in their lives. This will push up consumption. In addition, the NISA (Japanese version of ISA) limit has been greatly expanded, and concerns about inflation and expectations of economic growth have increased the desire to build assets through investment in securities. A major change for financial institutions is the growing recognition of the need for risk-taking. Many financial institutions have continued to invest mainly in Japanese government bonds despite abnormally low interest rates, taking only very limited risk, and have regretted the fact that rising interest rates have left them with many unrealized losses in their bond portfolios and curtailed their equity investments. Risk-taking requires a buffer of either sufficient capital or stable interest income. Having a large amount of capital often requires a lot of work. Stable interest income would allow financial institutions to take on more risk.

It is our belief that Japan’s ultralow interest rate situation was also a catalyst for Japanese people and institutions to invest abroad. This is why Japan is one of the major holders of American or Australian bonds. As interest rates go up, holding Japanese debt will also be a lot more attractive. Do you believe that rising interest rates will be a catalyst for Japanese investors to claw back some of their investments and place them in Japanese bonds and products?

It is true that Japanese financial institutions have invested in foreign bonds, but mainly with currency hedging. Regarding the risk ratio of life insurers' solvency margin, unhedged foreign bonds have a risk ratio of 11%, but only 1% if the currency risk is hedged. Many life insurers invested the majority of their foreign bonds in hedged investments. They have been severely damaged by unrealized losses from rising interest rates and negative yields from rising hedging costs. Since selling hedged foreign bonds entails a loss, sales will not proceed rapidly due to the constraint of selling within the gains to be made up. Although interest rates in Japan have risen, they are still around 1% for the 10-year JGB, which is much lower than the inflation rate, and with further rate hikes expected in the future, this is not an aggressive option. Meanwhile, the parent company, Fukoku Mutual Life Insurance, decided early in 2022, after COVID, that it was the best time to see how things were changing and to let go of many of the foreign currency bonds it held. We sold as much as we could, and for those we couldn’t, we converted from currency hedged to unhedged. We thought that the uplift of foreign currencies would cancel out the price of the declining bond. Other financial institutions were not able to do so because they did not have enough risk buffers.

When we talk about the rising interest rates in Japan, there is a big disconnect between what insiders think and what outsiders perceive. If we look at the past 18 months, there are two sides to the outlook of the market. On the one hand, there are a lot of pessimists who believe that Japan’s recent bullish run was mainly due to macroeconomic conditions. On the other hand, there are those who believe there was a series of transformative changes occurring in Japan. Should macroeconomic conditions normalize, will those internal reforms be enough to carry Japan’s bullish momentum forward?

I agree more with the optimistic point of view, but of course, this does come with some caveats. Some companies have benefited from the JPY depreciation, but of course, there are others that do better in appreciation as well. Generally speaking, the JPY depreciation has created a positive impact on Japanese companies. Companies that export, in particular, will be hit by the appreciation of the JPY. However, the current exchange rate level is too weak for the yen, and we believe that even if the yen appreciates to about 130 or 120 yen, it is still at a level that exporters can fully overcome. This is because of improvements in the capital efficiency of companies and an improved competitive environment due to the end of abnormally low interest rates.

The policy rate increase to 1% or even 1.5% would be accommodative, since inflation is still below 2%. The rate hike would have an overall positive impact on the economy.

The aim of the recent governmental corporate reforms was to increase the fundamental appeal of Japanese companies. This includes new efficiency rules, mandated price ratios, and threats of delistings. This has heightened corporate accountability and also long-term shareholder confidence. The early results have seen a substantial increase in share buybacks, with May 2024 seeing JPY 9 trillion Japanese buybacks already. How do you rate these reforms, and what further reforms would you like to see?

The situation has come to a relatively good position where capital efficiency has improved, and management is realizing the importance of increasing capital efficiency. The tradable stock standard required listed companies to reduce the number of stable shareholders in their favor, which had the effect of increasing management's sense of urgency about capital efficiency. Japanese companies traditionally have excessive cash because they have trouble finding good projects to invest in. With the positive outcome of the economy and the end of deflation, capital efficiency will surely increase. The attitude of companies toward investors has gradually changed with these reforms. Unlike our parent company, Fukoku Mutual Life, we are a small shareholder as a subsidiary, but it is commendable that many companies are now willing to engage in an ongoing dialogue. Japanese companies are still undervalued and have high potential.

In Japan, European and Asian investors have been leading the charge. However, the US has a relatively small presence in regards to the market size, averaging just JPY 65 billion worth of purchases per month from April 2023 to January 2024. A cut in interest rates could help unleash large amounts of capital from players who are famous for their focus on growth investing strategies. How do you expect foreign investment flows to unfold over the coming year, and what products and services do you offer to foreign investors?

I’m not sure of the exact number of foreign analysts and fund managers that focus on Japanese equity, but I’m sure the number was not enough. However, overall, Japan's price-earnings ratio (PER) and price-to-book ratio (PBR) are quite attractive. Land prices are low, stock prices are undervalued, in addition to that, the yen is undervalued. There are many attractive points for the Japanese market. We suppose this has pushed further investment into the Japanese market from foreign capital.

Last year we launched a new product that is not index-linked. Basically, it is more of a bottom-up active management. We have concentrated our investment on specific companies with high potential growth, and the product will surely be attractive to foreign investors.

Could you tell us more about your stock-picking strategy?

The FCM Japan Selected Stocks Fund includes approximately 20 stocks, which are selected with a focus on companies that can sustainably achieve ROEs that exceed their cost of capital. Based on this stock selection policy, a three-person management team selects the most suitable stocks to build the portfolio. Our goal is to select companies whose stock price will double in a 10-year span, or double the value of the fund itself, so we target a growth rate of about 7% per year. To better determine the value of a company and its eligibility for this fund, we meet directly with the company and engage in a dialogue about management resources, particularly management and organization.

Are there any other products or securities that you are currently developing?

Our strategy right now is pretty much just to strengthen what we already have. Our Japan Active ESG is our core pillar, so just brushing up on the funds we have currently takes precedence. By strengthening these funds, we can push forward our uniqueness, and therefore the launch of new product will not be scheduled.

The Japan Active ESG fund is a beneficial tool for institutions such as Shinkin Bank, a local financial entity. This tool can be used to expand investment. There are many small financial institutions that haven’t yet made any investment in equity markets, so by providing new channels for investment into Japanese companies, the financial institution can learn important points in our corporate analysis and value judgment and can also train their staff.

Your company is a pioneer when it comes to ESG investments, and on top of that, you have developed your own proprietary ESG assessment system in-house. However, in recent years, the ESG investment space has received its fair share of criticism over a lack of standardized assessment framework and a lack of performance, particularly considering that ESGs have performed less well than non-ESG-focused counterparts. How does your assessment system allow you to overcome some of the challenges associated with ESG investments?

Our mission is to correctly identify corporate value and invest in undervalued companies and, to do so, we take our analytics and stewardship activities very seriously. Discussions are held with companies on how to uplift the corporate value, and our company is very determined to prove the enhancement of a company's corporate value through its ESG initiatives. This process is quite a long-term one, evaluating value steadily. In terms of our ESG fund, we’ve seen a great performance. We select companies by quantitative screening, and also specifically looking at qualitative factors. Over the past 20 years, we have refined our interview processes to draw out the best ESG perspective and determine future growth. Not only do we ask questions from an analyst perspective but also from a responsible investment perspective. We think the fact that we continue to create alpha against benchmarks over a long period of time through this unique process itself answers your question.

Your company manages equities of growing economies, and to further this cause, you have partnered with Singapore’s UOB Asset Management (UOBAM). Can you run us through the advantages of this partnership? Are you currently looking for any new partnerships? If so, what does a partner of choice look like?

Tracing back to our partnership with UOBAM, it was back in October 2010 that we began our collaboration by the decision of the president at the time, thanks to his friendship with the management team of UOBAM. Fukoku Life Insurance has had a long interest in the Asian market, so they started investing in Asian stock markets advised by UOB Asset Management through us. We have strengths in ESG investment, and UOBAM was interested in ESG; an ESG-focused partnership was formed in 2019, enhancing ESG fund operations. We have proactively shared our unique take and how we are able to evaluate companies from an ESG perspective with UOBAM. We have been able to deepen our understanding of companies and strengthen our research capabilities through direct dialogue and sharing of results with companies throughout the Asia region. In addition to our analysts directly researching companies in the region, they come to Japan to interview companies and learn a great deal from each other, including ESG themes of each region.

We believe that future partnerships must be considered within the context of the Fukoku Life Group's overall investment strategy, while keeping an eye on global trends.

Imagine that we come back in three years and have this interview all over again. What goals or dreams do you hope to achieve by the time we come back for that new interview?

I strongly envision our company’s future where asset management capabilities are enhanced and I believe wholeheartedly that this future is achievable. I feel that by further deepening the expertise of our staff, we can strengthen our research capabilities, and if operational capabilities are strengthened, this will inevitably lead to improved performance.

For more information, please visit their website at: https://www.fukoku-cm.co.jp/english/