Your Next Portfolio Complementing Strategic Investment Partner

In March 2024, the Nikkei 225 roared past the JPY 40,000 mark, and this year so far has been a record-breaking one. We’ve seen a surge in initial public offering (IPO) activity, with 97 companies raising over JPY 570 billion, as well as a surge in private equity deals, tripling from 2018 to 2022 consecutively. This favorable backdrop has drawn an unprecedented flood of foreign capital into Japanese financial markets, with foreign investments in Japanese equities reaching a ten-year high. What do you believe are the core reasons for this extraordinary performance of Japan’s financial markets? What makes Japan so attractive to foreign investors today?

There isn’t one all-encompassing reason, and all of the things you mentioned are correct. Japanese IPOs, however, although large sounding, are relatively small compared to those in the U.S. or Europe. In this respect, there is still much to do. Going back to your question, I think one of the biggest reasons is China, and that the country has become less investable. Ten years ago, everyone was looking into China, and the economy was essentially moving there. The decoupling and the associated tensions are now casting a shadow. People are now looking for places you can invest in, particularly places with less risk, and Japan instantly fits the bill. It has infrastructure like the U.S. and basic common law. Obviously, nothing is 100% reliable; no country is, but it is a very investable market.

At the same time, there has been considerable corporate reform, and the Japanese government has done a really good job of promoting more corporate governance. Implementing these kinds of policies is complex since the government isn’t really imposing a law. Instead, they promoted a code to abide by. Japanese companies had a very different mentality in the past. The main objective in managing a Japanese-listed company wasn’t necessarily for profit. The main incentive was more to continue business “as is.” With the introduction of corporate governance, this mentality was forced to change.

In the past, when you achieved top grades at a top university, the ideal destination was to get into government. This wasn’t necessarily about prestige; instead, it was about power and using that power to make Japan a better country. In that sense, I think we have the smartest people running the county, and the stewardship code was a really brilliant idea. From my perspective, however, this is all just a start, and I think Japanese companies are still undervalued compared to global standards. Once they adapt to the methodology of how U.S. firms are managed, they will still have more upside. JPY 40,000 is great, but we could be looking at JPY 100,000 at some point.

Today, when people try to predict the outlook for Japan, there are two sides. On one side, you have pessimists who argue that Japan’s performance is mainly based on macroeconomic conditions such as the low interest rate environment and the devaluation of the JPY. On the other hand, you have the optimists, who believe we are at the cusp of a historic transformation and talk about corporate governance as well as the change in generation. A lot of the old Japanese CEOs who only care about survival are getting replaced with younger leaders who abide by international standards. Should macroeconomic conditions normalize, will these internal changes be enough to carry Japan’s bullish momentum forward and maintain the attractiveness of Japan?

All of these internal changes were a start, but now we need to move to the next stage. For example, in the asset management sector, the government is pushing for a policy plan to promote Japan as a leading asset management center. The Japanese government understands that the country has relatively limited investment management capabilities. The number of investment management companies registered with the FSA is only around 430 or so. Compared to this, the number of registered investment managers in the U.S. is well over 10,000, resulting in a huge gap. If you just count the number of hedge funds, it is over 1,000. Increasing the number of investment management companies will benefit the economy by further efficiently allocating risk capital. The Japanese government understands this and is promoting the registration of more investment management companies.

Another important aspect is that the ecosystem itself needs to evolve. Compared to the U.S., the number of private equity firms in Japan is limited, which means that there are going to be fewer M&A deals occurring. In the U.S., if you manage a company and you aren’t making a profit, private equity may come in and restructure or possibly consolidate. In order to do these M&As, financing is needed, and this activity will change not only the corporate landscape but also the financial landscape. With increased M&A, financial institutions will become more risk-return conscious. This will create more asset classes to invest in, which in turn will increase the need for asset management companies like us. I think, ultimately, it is about promoting a dynamic capitalistic economy, and we need to continue that in Japan. Traditionally, everyone here has been educated to "save" and not to "invest." For example, when kids get money for Chinese New Year or some occasion like that, their parents will tell them, “You should save that money.” If a child says that they are going to buy stocks, the grandmother may react negatively. The advice children would get is just to put it in the bank. The “right way” in the past was to deposit your money into the bank where it is safe. The challenge now is that there are so many banks, and the majority of people’s savings are in the banking system. This is causing an inefficiency since that money could be better invested elsewhere. The long-run effect was that fewer people were taking risks, and the majority of people didn’t invest in equities. This mentality needs to change more, and further acceptance of private equity will hopefully facilitate that change. As private equity becomes more popular, more people will start to recognize the value of owning equity.

We are now starting to see a lot of mega private equity deals taking place, such as Bain Capital’s massive act of buying Hitachi Metal. I think they have purchased 13 companies over the past three years if we are not mistaken. How do you foresee the private equity space evolving in Japan? Do you believe we are going to transition from mega deals to smaller businesses?

Yes, I believe that will occur as well. One reason is demographics. While there are many companies growing by delegating more power to the younger generation, there are also many businesses with succession issues. In the past, selling your business was seen as a culturally bad idea, and the buyout firms were often seen as “unfriendly.” As a result, many business owners worried about how to protect their companies from buyout firms. I think this mentality is changing. There are many companies in Japan that are struggling, but within those companies, there is much-hidden value in terms of niche technologies and manufacturing techniques.

Aside from the new NISA, the first investment vehicle for Japanese people is usually a mutual fund tracking global equities. Can the NISA account and those reforms in the investment environment and managers unlock capital and redirect capital from foreign strategies into Japan?

That is a good question. I think that retail is actually the smartest investor base. Assuming Japanese equities perform for an extended period of time, people here will further realize that Japanese equities are worth investing in, and the mentality will eventually change. If S&P 500 volatility increases and we see larger corrections more frequently, that may also incentivize people to look more closely at Japanese equities. In the U.S., despite the volatility, the long-term trend has been positive. Utilizing investment accounts that invest in Japanese equities over a long-term investment horizon is also important.

For example, India is doing a good job right now, as it has investment accounts that allow it to invest in a domestic investment program on a monthly basis. Most of the upside in India now is coming from domestic investors, not foreign investors.

Can you tell us more about the products and services your company offers to unlock these domestic investors?

We are usually referred to as a “gatekeeper” for Japanese institutional investors. We have ambitions to cater to the Japanese retail market eventually, but that is a long-term plan. Our job is to search and do due diligence on the best managers in a particular investment sector and help our customers invest with them. I think one strength we have is that we are an independent firm that is not committed to one strategy, and we are in a position where we can objectively select good investment opportunities. Our company’s objective is to introduce managers and strategies that benefit the portfolio of Japanese investors. Our strength is finding strategies that our competitors may find hard to access, such as frontier market equities or bonds. Emerging markets are a good investment, but in our opinion, frontier markets have a good risk-return profile.  Basically, we aim to find investment strategies that are relatively niche and that investors normally cannot access by themselves or with another Japanese asset management company.

If you look at the capital inflow into Japan from institutional investors over the past year, you can see that most of the capital has come from Asian investors who were pulling out of China. We’ve also seen that many U.S. institutional investors have yet to rotate within Japan fully, and the total capital of their investments is quite small relative to the market size. Do you cater to foreign institutional investors?

Unfortunately, we do not. Our main mission is to cater to Japanese investors who are looking to invest in alternative investments, mainly overseas. We also invest in Japanese alternative investments such as Japanese private equity and Japanese real estate, which is another attractive sector. If you invest with the right manager, I think you should be able to earn a healthy return in Japanese real estate. Our clients are basically domestic right now, but I do have ambitions of growing in the region and expanding towards Southeast Asia in the long run. In the long run, our goal is to create an all-weather type fund that offers a stable return of, say, inflation plus 3% that households can keep as a core holding in their portfolio.

In order to find investment opportunities globally, you need to have strong connections and a deep knowledge of market participants. Are you currently looking for partnerships to diversify your product offerings? If so, what does a partner of choice look like?

Since we are an asset management company mainly focusing on alternative investments, we are always looking for partnerships. We invest in about 70 funds right now with 30 outside investment managers. We consider those investment managers our partners. It is not our objective to compete with the major asset firms in the traditional investment space, and so we have focused on alternative investment strategies. Right now, we are just focusing on the areas that we think are promising.

Going back to your question, yes, we are always looking for good partners to work with.

Have you identified any potential new products you can share with us today?

One very interesting investment manager we have identified is a venture capital fund that makes seed-stage investments. The uniqueness of this manager is their heavy reliance on statistical analysis compared to traditional VC funds.

We saw in our research that your company was founded in 2009, making your firm relatively young in comparison to Japan’s other asset management firms. Nevertheless, you’ve been able to grow to over JPY 230 billion in a market such as Japan, which is known for being rather conservative. Why do you think you’ve been able to be so successful over the first 15 years of your company?

It is the result of everyone's efforts to work together. Also, I was fortunate to make some mistakes very early on. We started our company right after the Lehman Shock, and Japanese equity was undervalued. At the time, I thought it was the very best time to start a Japanese equity hedge fund. I worked for Citibank previously, and I was in a role that is very similar to now. Citi Alternative was a major alternative asset management firm, and I learned a tremendous amount about private investment there.  I wanted to explore a similar business model outside of Citibank with my own firm, searching for other good investment management firms. Initially, we were looking to partner with an equity hedge fund manager, but the project did not close.  I quickly learned some important lessons about this business. I learned that we had to team up with people that we could work with, and I feel very fortunate to have the colleagues I have right now. Team building is the core of any kind of success. With this same spirit, we still have much to do to grow our business. We needed, and still do need, to find like-minded people. It will continue to be a challenge for our team to find other teammates going forward.

ESG investments face challenges like a need for more standardization, low performance, and evolving regulatory demands. How is your company addressing the challenges to ESG investing?

You mentioned that ESG funds could be performing better, but there is an element to ESG funds that is a necessity since we are talking about the environment. Having good governance and social equality is a must. I believe in them, and long term, ESGs are something that has to be achieved. Currently, our main methodology is to screen investment managers by understanding their view towards ESG.

Imagine that we come back in 2029 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?

We hope to achieve the AUM of JPY 10 billion by that date. That is one core objective. We also want to be a listed company sooner rather than later. The reason is to have access to more capital so that we can invest in people. We need more infrastructure to increase our coverage, and being listed is one way to achieve that.

For more information, visit their website at: https://www.seiryuam.com/