Hello, everyone. Thank you for joining us today here in Hong Kong.

I’m David Soh from the RBC Asian Equity Team.

We’ve recently published an article titled, The Quiet Revolution: Active Investing Opportunities in Japanese Equity. And we are joined by the lead author and my colleague, Tomonori Kaneko.

Tomo, tell us about yourself.

Hello, everyone. My name’s Tomo.

Thanks for joining today.

I manage Japanese equity strategy in RBC’s Asia office.

Tomo, can you share your thoughts about Japanese equities today?

For global investors, Japan can be somewhat unique, or even tricky because the structural backdrop looks pretty challenging. But actual market performance has been pretty good.

That’s right, David. Some global asset allocators may not even bother to look at Japanese equity. With its aging population, the demographic story can look depressing. They may even call Japan [equity] an uninvestable asset class.

But in reality, the Japanese Index has done well, consistently. And active strategies have done even better.

It’s an interesting contrast to see that kind of market performance against that kind of structural backdrop.

Looking forward, do you believe Japanese equities will continue to be a good investment opportunity?

Yes, I do. Let me explain with some data.

On-Screen Text: Japanese equity performed consistently relative to major global indexes over the long term

This chart shows how the Japanese index performed against major global indices, since when Abenomics started or since the global financial crisis.

Japan was a good market to be in. So what is happening in Japan? History gives us some useful context to how we got here.

By history do you mean Abenomics?

No, not just that. I’m talking about fundamental drivers to the Japanese economy.

What have Japanese companies been doing for the past 50 years? To me, there’s a clear story that helps us understand where we are now, and where this is headed.

Right. So you’re saying, let’s look at the evolutionary trajectory to see where it’s likely to go. This is the part in the article where you describe how the Japanese economy goes through its lifecycle, building its economy as a global manufacturing powerhouse in the ’70s, the boom and bust in the stock market in the ’80s and ’90s, The Lost Decade, the global financial crisis, then followed by Abenomics.

Yes, that’s right. The important takeaway from going through that timeline, is how the Japanese companies would have faced challenges on trial and error, and evolved to survive. The global financial crisis was also a major wake-up call.

I really believe these hard times made the good companies stronger. Leaders will be able to see what I mean when they go through the data I put together for the article.

Good stuff. Tomo, you’re an active manager. You invest a great deal of your time talking to companies, and stock selection is how you outperform the markets. What do these learnings tell you about which kinds of businesses will generate alpha?

That’s a great question. There are a few things I see as structural drivers in Japan. Please see these charts.

On-Screen Text: Growth is a lot more dependent today on overseas

For the first thing is overseas sales. This drives top line when domestic consumption alone is weak. Overseas sales are now 60% of the economy.

Not only that, manufacturing is done overseas as well. Corporate Japan has always been a strong exporter, but it has now effectively evolved into a multinational corporation.

A lot of CapEx investments are made globally, localizing the business trends, to make the growth more steady and sustainable.

The other thing is domestic market consolidation. This includes profit margins and profits.

On-Screen Text: Domestic markets are becoming more profitable

Price competition goes down, as market consolidation continues. Some smaller players choose to sell their business. Bigger players streamline the acquired business to improve margins.

We can see how the overall profit margin improved significantly over the great financial crisis.

I hear you, Tomo. What you’re saying is that it’s not just Abenomics that turned around the Japanese economy, it’s really the companies that are driving fundamental change, and they have been actually striving to build competitive advantage for over a decade now.

Yes. And I’m trying to show you that with data. To be clear, Abenomics was important, but it was a catalyst. The basis for fundamental improvement in Japanese economy in markets were already in place years ago. But thanks to Abenomics, the process accelerated.

Okay. Let’s talk about that, Tomo. What did Abenomics do right? How did it act as a catalyst?

A lot of it was quite obvious and standard. It focused on improving the fundamentals of the economies, and it was pro-business. Like stabilizing the currency. It wasn’t like a radically new thing, invented by Abe. But it was all done at once, in proper magnitude, with good execution.

Take a look at this.

On-Screen Text: The demographic landscape is changing for consumers and the workforce

Inbound tourism grew massively since 2012. This was a material boost to weak domestic consumption.

Female labour participation jumped from 60% to over 70%, exceeding that of U.S. and Europe. This is not only good for diversity, but also helps to grow the workforce.

Then look at the growth in foreign students and workers in Japan.

I see. These are not only bold changes for a traditional Japan point of view, but they all help to offset the economic effects of weak demographics. It’s actually very clever.

So the economy is shaping up. Then what do you do? Wasn’t Abenomics also very proactive with investors?

Yes, that’s right. Some believe that these were even more important for the market.

On-Screen Text: Corporate governance is improving and GPIF is leading the way

During Abenomics, the Financial Service Agency, a government body, introduced the Stewardship Code and Corporate Governance Code, laying the ground rules for engagement between companies and investors. Since then, key metrics, like board structure and shareholder returns have improved significantly.

Government pension, GPIF, led the way of the other investors by increasing allocation in Japanese equity, and signed the UN PRI.

Wow. It’s almost hard to believe that so much has changed over the last five years or so. So, Tomo, does it concern you at all that Abe has stepped down recently?

No. I’m not deeply concerned. Changing leadership or change of any kind brings worries. That needs to be watched, of course. But new administration is no different from previous administration in substance.

Suga has worked together with Abe for over a decade as his best man.

That’s a fair point. But then a better question could be, what about after Suga? He is finishing Abe’s term, so he only has about a year or so.

Technically that’s correct, but many things can happen in politics. There’s also talks of him calling an election to get a fresh mandate. If that goes through, he may be serving for years.

But more importantly, as a fund manager and an economist, I don’t see politics as a key driver anyway. The quiet revolution in Japan is a corporate driven change that is well supported and sustainable.

Effort has been made over a long period of time to shift the economy in the right direction. Mostly by the companies. What we saw during Abenomics is like a good proof of concept that this transformation is real and it’s just beginning.

Hence the title of the article, A Quiet Revolution. We’re seeing big structural changes, while perhaps not all global investors are taking notice yet. And you don’t think it’s a bit late to increase allocation towards Japan equities?

Not at all. When I compare economic fundamentals, like ROE, profit margins, also things like shareholder returns in Japan, against other developed markets, there is still good room to improve. I believe this improvement is a gradual and multiyear theme.

The other reason it’s not too late is because I think Japanese equity is still an overlooked asset class. That also creates great opportunities for active managers.

This is a chart I like to show when I compare average number of sell-side analysts of U.S. equities.

On-Screen Text: Japanese equities are under-research compared to the U.S. or even Asia, based on sell-side coverage comparison Average number of analyst coverage

They have almost 10 more analysts than Japanese equities. Even for large caps, for companies with market cap between US$2 billion to US$5 billion, U.S. equity has about twice the number of analysts.

If I go below $2 billion, Japanese equity has practically no coverage. I think this makes Japan a great ground for stock pickers.

Yes, even the contrast between Japan and Asia is quite surprising.

So, Tomo, allow me to recap a bit. You’re giving a few solid arguments here. One, you’re confident on long-term growth in Japan. The business model of the country, the industry structure of the country, it’s going through a big change for the better. This not only brings growth, but also re-rating to the world’s second largest developed economy.

And two, because it’s changing, investors need to invest in future winners, not passively hold the index. The index will be too slow to adequately add future winners.

And third, stock picking and active management can be particularly rewarding in Japan today because it’s still overlooked and under-researched.

Did I get that right, Tomo?

I could not have said that better, David. Our Japanese equity strategy allocates up to one-fifth of the portion toward what we consider to be hidden gems, found amongst small- to mid-cap companies. This has been an important source of alpha for us.

However, investment in this space is not without risk. We really need to get our stock selections right.

And can you tell us how RBC does that, Tomo?

Needless to say, the most important part is to do our own research. We need to have our own rigorous internal research process, and insights to identifying strong business models and execution.

The other part is to be long term and really engaged with the management. We need to be on the ground.

Also, high awareness of risks in portfolio management is important. Our portfolio engineer constantly provides insights on portfolio constructions and factors risk profiles.

Our sector specialists study through the business models and industry trends to consider potential, nonfinancial risks from E, S, or G. It’s a team effort.

Is there anything else that you would consider unique? Maybe even an edge?

Times are changing. More and more Japanese companies are global businesses. The incremental bias for Japanese product is likely to be a Chinese or an Indian consumer.

Even domestic-focused business, they may be adopting a new internet-based business model that has been proven in China or globally. I work with sector specialists across Asia, including Japan. I often travel to meet companies with these specialists to see Japanese companies, as well as Chinese or Indian companies.

So how you’re seeing things could be quite different than say a Japanese manager just sitting in Tokyo and only talking to Japanese management. They may own companies that generate most of their revenue from overseas, but not really understand how that foreign consumer thinks.

Yes, that’s the idea. We try to pair good local perspective with our regional or global perspectives.

That explains a lot, Tomo. I think we covered good ground. We went through your long-term views on Japan equities, how you approach alpha generation through stock selection, and also unique aspects of your team and your investment process.

Tomo, is there any last remarks as we wrap?

When we meet the companies, we look for a company with a long-term vision and plan. When we meet our potential investors interested in Japanese equities, we want to get it across that we have very competitive solution for our investors. We are keen to have some good conversation and share our learnings, while at the same time learning from our investors.

Thank you very much for joining us today.

Thank you, everyone. Cheers.