Investing In Japan

I don't usually do book reviews on this blog mainly because I rarely read a book that I think most readers would benefit from.  At times I've mentioned books that I think go well with a certain topic, but so far I haven't done a full scale book review.  This post is a first, and because I write about Japanese equities often this book will probably appeal to most readers.

Investing In Japan was written by Steven Towns a member of the proxy exchange and author of the blog Active Investing where he writes about shareholder activism and Japanese companies.  He has been a long time holder of Internet Initiative Japan and through shareholder proposals and discussions with management was able to get IIJ to increase their dividend 50%.  One aspect of this book that I really loved is that Steven Towns is a value investor himself and presents Japan through the eyes of a value investor.

For this review, I want to hit a few highlights from the book to give you a taste of what it contains.  I've seen reviews on Amazon where people give a summary of each chapter and my own take is if you want that much detail just go buy the book.

How to invest in Japan with ETFs and mutual funds

This was an interesting aspect of the book I didn't really expect, Steven dedicates two chapters to discuss different exchange traded vehicles for investing in Japan.  Towns uses ETFs to walk the reader through some basics on the Japanese market such as the different market sections, relevant indexes and index composition.

What I found really fascinating was the concentration of investments by the value funds represented in Japan.  Most of the value funds own the same set of large cap exporter stocks such as Toyota, Canon etc.  What's interesting about this is that the top holdings in most international value mutual funds are the same as the top holdings in Japanese index funds.  In most cases a value investor is better served either diving in and investing in individual equities on their own or buying a Japanese index fund for inexpensive exposure.  I would say that if someone wanted a lot of Japanese exposure an index fund to capture large/mega caps along with some individual small cap stocks is probably the best approach.  Of course I'm biased because this is what I do.

Macro/Bearish outlook

I would say the biggest thing holding back most investors from putting money into Japan is macro economic fears.  These fears stretch from worries about government debt, zero interest rate policy, low GDP,  a declining birth rate and a whole host of other worries.  Of course the worst time to invest is when it seems like there aren't any problems, or all the problems have been solved.  Given all the worry about Japan valuations are at twenty and thirty year lows with profitable companies selling for less than the net cash on their balance sheet.

I'm not going to go into a counter point for each bearish argument against Japan because Towns does a great job.  He discusses how fears of a Yen drop are mostly exaggerated, just a few years back companies were managing just fine at the ¥120-130 level, and are now managing alright at the ¥80 level.

The chapter also discusses Japan's supposed demographic time bomb and has a quote that I love:

"My point is for readers not to be misled to believe that Japan is so gray as to be on its last breath and in such dire straits that masses of unemployed youths pass time by occupying ubiquitous internet cafes."

He ends the chapter with the exhortation that any reader interested in Japan should at least make a visit.  Lost in the bearish investment speak is that Japan is an extremely modern country that's very safe to live and travel.  It seems every country right now has some sort of macro overhang even the US.  There is no place perfectly safe, investors just need to be mindful of the risks.

The one area I wish he would have covered here some some advice on hedging the Yen.  A fall in the Yen would be good for Japanese business, but I wonder if the increase in business value would offset forex losses.  I would rather hedge or partially hedge and get the best of both worlds.

Stock market essentials

There were two chapters covering everything from the history on minimum trading units to Japanese dividend policy.  There was a lot of information in these two chapters that I wish I had in one place before I started investing in Japanese companies.  I spent a lot of time Googling trying to figure out some of the peculiarities of the Japanese market.

The chapters on the market essentials also covers the often discussed cross shareholdings that many Japanese companies have.  One form of cross shareholding that's popular is listed subsidiaries.  I own a listed subsidiary and wondered what that reason was for the listing.  In Japan spinning off a company has some tax consequences that make it unattractive.  Instead of spinning off a subsidiary a parent company will simply list the sub.  There's some catalyst potential in parents taking listed subsidiaries private if the sub is very profitable and the parent wants control of the income stream.

Low ROE problem

It's not a secret that most Japanese companies have low ROE's compared to most other developed countries.  A lot of investors will get excited by the cheapness of Japanese companies and then see a ROE of 3.5% and end up walking away from the stock.  The book digs into the multitude of reasons that many Japanese companies have low ROEs.  The biggest is that most companies are overcapitalized both with cash and assets.  A second aspect is that many Japanese companies will invest in plant and productivity rather than trim the workforce because that's the easiest path forward.  This results in lower returns and inflated assets, assets that might be used eventually if Japan regains it's mojo.

Shareholder rights

The chapter on shareholder rights was tucked in the back, I think unfortunately because most investors don't care much about any rights they hold.  With that said this chapter is pure gold, Towns knows what he's talking about when it comes to shareholder activism and rights.  Interestingly enough an investor who owns more than $2000 of any Japanese stock has quite strong legal rights including the ability to call a board meeting.  The chapter lays out some specific rights all shareholders above the threshold have as well as going into some details on executive pay.

I wish there were more stories and concrete steps for an investor to take.  One takeaway I had was that Japanese companies aren't opposed to shareholder proposals but that most foreign investors propose incorrectly and ask for demands that are too large.  Investors who understand Japanese culture have had a lot of success in initiating change in corporate Japan.

Who should read the book?

I think any value investor who's curious about the persistent undervaluation of Japanese equities should do themselves a favor and read this book.  For someone who has been investing in Japan for years they might not have as much to gain from this book.  One thing that's worth mentioning is that Steven Towns sprinkles the book with lots of examples of undervalued companies and just the examples in the book alone are a great hunting ground for an aspiring Japanese stock picker.

Buy Investing in Japan: There is no stock market as undervalued and as misunderstood as Japan from Amazon.com

Disclosure: I purchased the book on my own.  If you order through the links above I will receive a small commission.  The price for the product is the same if you enter through my site or go to Amazon.com directly.