Research

Last month we wrote in rather uninspired terms about the revaluation of the renminbi. This month's "news" story is much more important.

Only in Japan could the convincing re-establishment of an almost 60-year old political dynasty be called news! But Koizumi now has both a clear mandate in personal terms, and a near-invincible political toolkit, to force real change in Japan.

The world's second-largest economy's desperate sclerosis has become almost a commonplace. We have already seen how much of the country's needed macro-level changes have been passed on to the micro level (that is, how much corporate Japan has had to restructure). Now, for the first time in my professional lifetime, it looks like Japan may achieve structural change, and, even more amazingly, have a functioning democracy, empowered to deliver a popular mandate.

Despite having lived and worked in Japan, and speaking the language, I have rather neglected the Japanese hedge fund industry over the last few years. Shortly after GFIA started, in 1999 we conducted a detailed review of Japanese managers, but in the interim have visited Tokyo only two or three times a year, briefly, to catch up on developments.

In August we spent a full week visiting managers and talking to market participants. The summary is that Japan is, in our opinion, likely to play a very aggressive catch-up to the rest of the Asian, and by inference the global, industry, over the next couple of years. The drivers are summarised as:

• The total size of Japanese equity markets is US$5.7tn compared with US$10.4tn for the rest of Asia combined. For fixed income markets, the numbers are US$10.2tn and US$11.8tn respectively. However there are approximately¹ only 100 hedge funds focused purely on Japan compared with 580 that include or focus on Asia. Japan is undersupplied with hedge funds.
   
• Daily turnover in the equity markets is US$14bn. Out of the 2,400 companies listed in Japan, there are hundreds of stocks with average daily turnover in excess of US$1m. Japanese hedge funds are likely to have higher available capacity than Asia ex-Japan funds.
   
• Japan has been in a 17-year bear market, and therefore has not been the place of choice to build a career for international financial professionals². However local professionals have typically remained engaged, and have become adept at creating some level of return in difficult environments. We are now seeing many local professionals transferring their skills into hedge fund environments, thereby expanding the pool of talent.
   
• There is a growing sense that Japan is at last engaging with some of its fundamental problems. Koizumi's stand on the Japan Post privatisation is indicative of a genuine democratic political process rather than the LDP's shadow-play of the last 60 years. There is open discussion of the problems of a shrinking population (by 2050 some commentators suggest that the Japanese population may have halved, compared with a doubling of that in the US). Japanese corporations have embraced restructuring in the name of profitability. The collapse of the cross-shareholding network has meant that most of the Japanese stockmarket is in the hands of economic investors looking for returns, rather than strategic stakeholders looking for stability³.

The highlights of the meeting programme were as follows:

• We saw a number of outstanding new propositions, that we suspect would withstand rigorous due diligence, and who will have meaningful capacity.
   
• We heard from prime brokers of very full pipelines of new managers intending to start in the next 12 months, including a significant proportion of large global hedge funds intending to set up operations.

The overriding theme at the investment level is the opportunity afforded by drastic change. Many of the more interesting strategies are clearly designed to (or are already) take advantage of the fundamental restructuring of Japan, at a very hands-on level.

• The fashionable "activist" funds will make money, but appear to me to be mutton dressed up as lamb. Clever, cutting edge concepts they are not. By taking stakes in companies and then working with the management to move up the share price whether by broking deals, polishing the presentation, or working with the street to get the story out, they are playing the oldest game in the stockmarket book. British stockbrokers pre-big bang did it. Several maverick funds across Asia have been doing it for years. For entrepreneurial managers with a market presence, an inefficient and grossly under-researched equity market, and investors looking for turnaround stories, this is one of those "shooting fish in a barrel" propositions.
   
• Similarly we saw an interesting property fund which proposes to "take the grubby end of the Japanese property business and package it for institutional investors". This is not rocket science; it is using market presence and entrepreneurial instincts to engineer returns.
   
• We revisited Tower, who I last saw in 2000 (and first saw in 1998). While the organisation has remained exceptionally stable, in the same office, with a headcount that has expanded over five years from 12 to 13, the investment strategy is radically different. The team is using its access to capital, market contacts and entrepreneurial skills, to involve the fund as principal in a number of commercial ventures-including some "activist" projects.
   
• One of the new managers where we would like to do more work is focusing on stressed companies-in other words, they are investing long and short in listed and performing securities, but focusing on those companies whose business model or balance sheet is in distress.

Finally, I was struck by how livable Tokyo is. It was always a safe, stimulating and very alive city. Now, though, it is much more cosmopolitan, there is infinitely more choice of consumer items, entertainment, multiple price points for goods and services and much more evident diversity on the streets. While Hong Kong may have the China story, Shanghai may have the wild west cachet, and Sydney may serve the hippest latte, Tokyo is much more clearly the obvious sibling to New York and London than it was in the late 90s.

Footnote

¹ Eurekahedge covers at least 90% of the actual universe; our numbers are sourced from Eurekahedge and grossed up appropriately.

² Although restructuring, distressed investing and retail distribution specialists would disagree!

³ This last comment was written before the election-but now holds truer than when we wrote it!