Japan: The Reborn Phoenix
Interview with Stephen Hill, Senior Portfolio Manager, Japan Equity
MFC Global Investment Management
MFC Global Investment Management (MFC Global) is the brand name for the diversified investment management group of Canadian-based Manulife Financial Corporation. MFC Global consists of several companies with investment offices in Toronto, Boston, London, Tokyo, Hong Kong and Southeast Asia. It has more than 100 years of experience managing portfolios for The Manufacturers Life Insurance Company, John Hancock Life Insurance Company and other major clients. MFC Global is a leading global investment management group with more than US$200 billion in assets under management worldwide. Through its affiliates, MFC Global is currently responsible for US$1.5 billion of assets invested in Japanese markets.
MFC Global’s investment philosophy for managing its Japanese equities is to generate above-average, long-term returns by identifying those sectors and companies with solid, ongoing growth prospects. The investment process begins with top-down macro economic analysis of world and Japanese markets, augmented with research that identifies industry sectors with the best long-term potential for growth. Risk controls are in place to assure diversification across sectors. Industry-leading companies are assessed for their business prospects, financial position and calibre of management. Quantitative analysis then identifies top quality stocks with acceptable downside risks. The buy-and-hold strategy, which keeps average annual turnover at approximately 25% to 30%, includes continuing risk review and analysis of the 40 to 60 names typically held in a portfolio.
Stephen Hill is Senior Portfolio Manager, Japanese Equities based at MFC Global's London investment office. He has more than three decades of experience investing in the Japanese market, including managing large equity portfolios and Japanese institutional pension funds. In 2005 and 2006, The Japanese Growth Fund of Manulife Global Fund, managed by Hill, received Lipper Fund Awards Hong Kong 2006, Best Fund over 10 Years of Equity Japan and SCMP Fund Manager of the Year 2005, 10-Year Award of Equity Japan. Recently, Stephen was interviewed by a professional fund management periodical on the market outlook of Japan equities, which has been summarised below.
What is your overall outlook for Japan’s economy?
We are positive on the Japanese economy for the long term, despite Tokyo’s poor performance relative to world market year-to-date. The Nikkei was down 10% from its high-point in April which we attribute to worries over lower export growth to the US as the American housing slowdown bites into the US economy. There was also significant profit-taking in the Japanese market after the strong gains from the last fiscal year, plus disappointing consumer demand given Japan’s improving employment rate.
But the Japanese economy is not in bad shape. Corporate profit margins are at high levels and appear to be sustainable. There’s been a return of both corporate and consumer confidence now that deflation seems to have ended. Inventories are low and capacity utilisation is high, which favour increased investment. Another positive factor is the renewed strength of Japanese banks, which will be able to play their full part in providing the finance required for sustaining economic growth.
Regarding international trade, Japanese exports continue to sell around the world based on quality, not price. We think Japanese exports will likely remain globally competitive, due to its need to import natural resources and maintain a balance in trade. Japan’s export growth will be linked to overall worldwide demand, rather than relying on any particular market. Any changes in the US economy will affect Japan only to the extent that American markets affect overall global demand.
In the coming years, what sectors of Japan’s economy do you expect to drive growth and be most profitable?
Changing demographics and increased spending will drive growth. Japan’s demographics suggest that saving rates will continue to fall, leading to a higher propensity for consumers to spend. Meanwhile, we are seeing the rise of the retired class – those 60 years and older – and the reduction in "salary men" who enjoy the security of career-long employment. The result is companies are planning to increase their capital expenditures and shifting their employment practices, such as hiring more women. Consumer sector spending will likely rise as the number of working women increases.
Clearly the banking sector has potential to gain the most in terms of profitability, however, profit margins across all industries have recovered strongly. The focus on profitability will be maintained by Japan’s new breed of corporate management and its empowered shareholders. We expect both groups to concentrate on sustaining profits, rather than attempting to build market share.
What’s driving corporate profitability?
Corporate restructuring activities designed to improve efficiency and save money are now largely complete. With the new management emphasis on growth and profitability, I don’t see the hard-earned productivity gains of the past getting whittled away. Improved pricing power is also a likely source of profit as inflation increases and consumption returns to its past levels.
Given the strong improvement in productivity that can result from ongoing capital investment, coupled with continued growth in Asia and the rest of the world’s emerging markets, it is very realistic to expect that Japan’s economy can grow by 2.5% or more during the next decade.
What economic issues/reforms need to be addressed for such sustained growth?
Clearly the budget deficit will have to be addressed, however, I am confident that it will be brought under control by a combination of tax revenue growth and reduced government spending rather than through a significant increase in tax rates.
What is your outlook for Japanese monetary and economic policy?
Monetary policy will remain accommodative to ensure that the economy does not return to deflation but will normalise to ensure that inflation remains under control. On economic policy, I expect that at some point there will be an increase in indirect tax, possibly offset by reductions in direct taxation. But any of these changes will need to wait until the new government is more certain about the sustainability of Japan’s economic growth.
Will changes in Japan’s foreign policy affect the business outlook?
The current strains we’ve seen in Japan’s relations with countries such as China and South Korea haven’t had any meaningful effect on Japanese businesses. At the ground level, I don’t see any significant change. If relations do improve, some big “trophy deals” may emerge, such as Airbus-type partnership announcements made with China.
The views expressed are those of MFC Global Investment Management® as of October 2006, and are subject to change based on market and other conditions. All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, financial or legal advice. Investors should seek professional advice for their particular situation. Neither Manulife Financial, MFC Global Investment Management®, nor any of their affiliates or representatives is providing tax, financial or legal advice.
MFC Global Investment Management® and Manulife are trademarks of The Manufacturers Life Insurance Company and are used by it and its affiliates including Manulife Financial Corporation.
Investment involves risks. Fund prices may go down as well as up. Past performance figures shown are not indicative of future performance. Please refer to the Prospectus for further details.