Baillie Gifford Japan Forum: Steering through rough seas
- The London Investor Forum set out a key task for Baillie Gifford’s Japan Team: to distinguish temporary setbacks from permanent change
- Understanding what makes companies resilient helps to predict long-term success
- Entrepreneurial companies are finding new ways to disrupt established markets
All investment strategies have the potential for profit and loss, capital is at risk. Past performance is not a guide to future returns.
Bedecked with admirals’ portraits and polished maritime memorabilia, Trinity House in the City of London is the venerable headquarters of the General Lighthouse Authority. Whether by accident or design, nautical metaphors featured in Baillie Gifford Japan Forum there on 24 November, entitled ‘Unlocking Japan’s Upside’.
“Setting sail to a destination involves challenges along the way,” explained Matthew Brett, manager of The Baillie Gifford Japan Trust and the firm’s Japanese Fund. “Our general approach is to sail the ship through that volatility.”
Brett compared the temporary setbacks some Japanese companies are facing to storms and rough seas. The far more dangerous rocks and icebergs, he suggested, were irreversible behavioural shifts that can destroy the case for some stocks forever. The goal of the Japan Team, he said, is to “unpick the differences between a temporary setback versus situations where we have to acknowledge that real change has happened”.
Photocopier makers were a good example of the latter. At one stage, the Japanese portfolio held four photocopier stocks. Now the way information is consumed has changed. People carry around digital copies of documents on tablet computers instead of the bulky paper files that Brett recalled lugging around Japan on early trips there. Instead of photocopier stocks such as Canon, the portfolio now holds shares in electrical components maker Murata Manufacturing and Wacom, which produces styluses – electronic pens for use on tablet screens.
Another example of permanent change came from finance, where the competitive advantage of a large branch network has been nullified by the convenience of online banking. Where 10 or 15 years ago, megabanks such as Nomura featured in the portfolio, they have now been replaced by the likes of financial technology firm Rakuten and SBI. “We used to describe SBI as Japan’s leading online brokerage,” Brett pointed out. “Now it’s simply Japan’s leading brokerage.”
While it’s easy to spot those permanent changes with hindsight, his Team’s task is to anticipate them. He highlighted two current trends that they believe represent equally important shifts – energy and transport.
In the field of energy, he singled out the switch from hydrocarbons to renewables. Liquified natural gas is seen as a transition fuel between coal and renewables, which used to earn Inpex – Japan’s largest oil and gas extractor and producer – a place in the portfolio. But now Brett believes Russia’s invasion of Ukraine and the ensuing energy crisis have helped to accelerate a move away from hydrocarbons. Instead, companies that will benefit from electrification, such as Sumitomo Metal Mining, are likely to grow.
In transport, the Team believes traditional Japanese car makers are likely to be left behind by the arrival of cheaper electric vehicles (EVs), especially from China, because many have focused on hybrid cars and others on cars powered by complex hydrogen fuel cells. “At the moment, we think that the Japanese auto assemblers look like they’re very good at making the cars of the near past, but not the future,” added Brett.
Weathering ‘temporary setbacks’
In contrast to stocks facing permanent change within their sectors, Brett highlighted how the market had undervalued companies whose setbacks he believed to be merely temporary. One eye-catching example was gaming giant Nintendo, shares in which plummeted following the unpopularity of its Wii U console in 2012. This reverse, he said, was caused by competition from games on mobile phones. Shares duly recovered, partly thanks to the popularity of its Switch handheld platform launched five years afterwards.
“People were looking at the wrong things when they were looking at the consoles,” Brett explained. “They were looking at the current manifestation of Nintendo’s intellectual property, rather than taking a proper long-term view, which is that Nintendo isn’t actually about those consoles – it’s about the characters, the software, the brands. That’s what made that setback temporary, rather than a permanent change, and allowed growth to return.”
Tyre maker Bridgestone fell into the same category for Brett. He viewed a fall in the company’s operating profits during the Covid-19 lockdowns – when, naturally, fewer vehicles wore out their tyres – as a temporary setback, rather than a permanent change. “The core insight here for us is that the tyre is like a shoe for a car,” he said, pointing out that EVs need tyres as much as traditional cars. “That is what gives us the conviction that we’re experiencing a temporary setback that recovers.”
Cosmetics firm Shiseido also suffered due to Covid-19 but is yet to recover, due to the ongoing restrictions in China. Once China’s growing middle class can travel abroad again, Brett believed they will return to buying cosmetics. The point was reinforced later in the Forum by special guest Masahiko Uotani, Shiseido’s President and CEO.
From ‘resilience’ to ‘resilience-plus’
The panel discussion in the Forum’s final session took up and developed the theme of a company’s resilience in the face of temporary setbacks. The discussion was chaired by Baillie Gifford’s Head of Japanese Equities, Donald Farquharson. It set out to discover the ingredients to an enduring and ‘antifragile’ competitive edge.
“We’ve long understood the basics of a resilient business: one operating in an area of strong repeat demand, with a lowly indebted balance sheet, the ability to self-fund growth, no nasty hidden liabilities on the balance sheet, high margins, and low fixed costs,” Farquharson explained.
“A synonym for static resilience is ‘quality’. We’re trying to look beyond this to ‘resilience-plus’, or a more dynamic competitive advantage.”
One element of shifting from resilience to resilience-plus involves a company increasing its competitive advantage. Tolibjon Tursunov, co-manager of the Japan Growth Strategy, assessed companies’ competitive advantage by looking at internal factors – such as whether they’re investing in research and development or technology – and external factors, such as changes to regulations or customer habits.
He pointed to accountancy software firm freee K.K., which will benefit from changes to regulations that will make it easier to file tax returns online, and Keyence, which began simply by selling sensors but now also analyses data from those sensors and offers advice to its customers.
Praveen Kumar, manager of both Baillie Gifford Shin Nippon Investment Trust and the Baillie Gifford Japanese Smaller Companies Fund, split his definition of resilience into three categories: operational; financial; and managerial. Unique companies that are genuinely disruptive and innovative will come to dominate their chosen market, giving them operational resilience, he said.
Examining financial resilience involves thinking about how the company will look in five years, not how it looks today, Kumar explained. This is especially so if low margins or low returns are due to aggressive investment. Assessing managerial resilience requires looking beyond the founder to the second tier of management, he added.
Kumar shared the example of GA Technologies, which runs a property website that combines selling or renting homes with other services, such as mortgages and cashflow projections for investors, and is using artificial intelligence to disrupt the market. Japan’s real estate sector is heavily regulated, putting up high barriers to entry, while the company, founded in 2013 by former football player Ryo Higuchi, has gone from making sporadic profits to becoming more reliably profitable as it scaled up. Kumar said he was impressed by the calibre of its senior executives.
Management’s vision was also a key factor for environmental, social, and governance (ESG) analyst Cian Whelan, especially when linked to a company’s culture and clear sense of purpose. He pointed to human resources technology firm Recruit, whose entrepreneurial leaders encourage staff to develop and spin out their own businesses, and which develops websites such as Glassdoor that increase transparency by publishing online reviews of what it’s like to work for a particular employer.
Satoko Ishino, one of the Team’s two Tokyo-based company researchers, highlighted the unique business model of television streaming website Abema, in which CyberAgent owns the majority stake. The website can tailor its content in response to events, such as broadcasting emergency information during earthquakes or pay-to-view concerts when singers couldn’t perform in venues during the Covid-19 pandemic.
Ishino added that CyberAgent demonstrated how Japanese management culture was changing. The familiar Japanese phrase “The nail that sticks out gets hammered down” illustrates the peer-pressure dynamic that instils a sense of teamwork among employees and loyalty towards an employer, making it hard sometimes for start-ups to recruit. While CyberAgent has now grown to become a large company, it still retains an adventurous spirit, she explained.
“Japan now has a good balance between that teamwork and job security, and that more adventurous spirit,” Ishino added. “This balance is going to help Japan regain competitiveness in the global economy.” That note of optimism echoed throughout the Forum. It contributed to the sense that Japan’s best companies were steering the correct course, even if we can’t expect plain sailing.
Research consultants Satoko Ishino (left) and Akiko Hirai (right), the Team's eyes and ears in Japan
For on-the-ground intelligence, the Baillie Gifford Japan Team turns to Satoko Ishino and Akiko Hirai. Forum attendees were introduced to the Tokyo-based pair, who draw on decades of market experience and network-building to bring exciting growth companies to the Team’s attention.
As the eyes and ears of their UK colleagues, Ishino-san and Hirai-san go far beyond the conventional corporate ‘investor relations’ circuit, talking to employees at all levels to inform themselves about a firm’s culture and prospects. Steeped in Japan’s ongoing industrial, regulatory and societal changes, their sources include industrial researchers, trade shows and media reports. All help to inform and challenge Edinburgh-based investors’ perspectives.
Before joining Baillie Gifford, Hirai-san covered a range of Japanese industries for asset managers Schroders and Amundi. Her specialism was large-cap companies, from consumer electronics giants to trading firms.
“At Baillie Gifford we don’t analyse quarterly financial results, we’re more interested in the long-term opportunities arising from bigger changes.” She says. “For a researcher, not being a sector specialist is an advantage as it helps give us a fresh view.”
For Ishino-san, scouting for companies on the right side of change allows her to exercise imagination and critical thinking. Also an ex-Schroders analyst, she has returned to company research after a spell studying cooking in New York.
Two decades of specialising in small and mid-cap companies have tuned her antennae for entrepreneurial leaders capable of growing companies, sometimes by exploiting societal shifts.
“Japan’s old tradition of peer comparison provided strong job security and teamwork. Now new industries grow up quickly and existing companies need rapid change, so we’re looking for strong, visionary leadership”.
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