The last week of June saw the conclusion of an eight month boardroom battle at LIXIL, one of Japan’s largest building material and equipment businesses. The outcome – the return of ousted former chief executive Kinya Seto, who had been successfully restructuring the business – is a welcome example of how corporate governance could be a significant driver in the turnaround of Japanese equities, delivering better returns for investors.
Since President Shinzo Abe came to power over six years ago, Japanese equities have significantly outperformed global equities in both local currency and dollar terms. Driving this are factors including economic reforms, corporate reforms and, very importantly, a tangible improvement in corporate governance.
This might come as a shock to those investors who have not been paying close attention to events in Japan. However, for those who have, the improvement in corporate governance has been one of the decisive drivers of higher shareholder returns.
A year ago, the enhanced revision of the Corporate Governance Code came into effect, and I wrote a blog entitled ‘Making Japan Inc work for investors’ about how that would further force companies to focus on shareholder returns and how it has given investors the tools to affect changes at the companies in which they invest. Now, we are beginning to see real life examples of the positive affect it is having on corporate governance.
LIXIL has served as a wide-reaching case study for corporate Japan. Investment managers and company management have paid close attention to the developments in the past few months and will have taken note for their future dealings.
In late 2018, one of the founders of LIXIL abruptly dismissed the chief executive, Kinya Seto, and reversed many of his initiatives aimed at restructuring the business. Investors were left in shock and the company lost around a third of its value.
While one can argue that firing an underperforming chief executive is the correct way to manage a company, this was widely seen as not being the case. Many investors, including ourselves, saw this as an attempt to preserve ‘old’ business attitudes, at the expense of shareholder returns. The share price collapse reflected this.
LIXIL has been in the spotlight this year, as Kinya Seto rallied both foreign and domestic investor support in order to restore him as chief executive, as well as electing a new board. After a lengthy proxy fight, investors have finally had their say. It is important to point out that Kinya Seto also commanded significant support from within the company, so this outcome is positive for internal stakeholders too. We believe his return as chief executive, and plans for restructuring the business, will unlock value for shareholders.
While this episode has produced significant volatility for LIXIL’s share price, as well as costing both the company and investors money, it is worth emphasising that this is another turning point in Japanese corporate governance.
Even with wide support from active investors, the ousted chief executive’s efforts to fight back were considered extraordinary and, many cynics argued, futile. This is because, traditionally, Japanese management are rarely challenged due to connections, cross shareholdings, and simply a lack of willingness for domestic investors to challenge the incumbent.
However, things have changed. Many Japanese institutional investors who are now obligated to cast their vote on issues such as these and, furthermore, are expected to explain their decisions, joined many foreign investors in voting against the LIXIL board. This is precisely what last year’s revision in the Corporate Governance Code aimed to achieve. One can argue that Abe’s administration has successfully changed historically ingrained attitudes in corporate Japan through social threats and incentives, rather than hard legislation.
Japanese institutions can no longer hide behind apathy and avoid situations that could cause their contacts to ’lose face’. These latest corporate governance developments are a huge step towards the Japanese equity market being considered as a serious market that is working for investors, rather than for company management.
2018 was a record year for investment by Japanese companies and, where growth opportunities were absent, cash was increasingly returned to shareholders. For the financial year ending 31 March 2018, over two-thirds of large-cap companies increased their dividend, versus only 10% or so that cut their dividends. In addition, against a background of slowing global growth, share buybacks reached record levels – with corporate Japan actually increasing its ratio of share buybacks (cash distributed to shareholders relative to market capitalisation) over the same time period.
This is further evidence of both top-down policy, such as the Corporate Governance Code, and bottom-up engagement from domestic and overseas investors, working together to improve conditions for investors in Japanese equities. Consequently, we have gone from a situation where dividend yield was rarely mentioned in Japan, to one where the yield is now above that of the US stockmarket.
One might expect this positive news to be already priced in by investors. However, looking at the price action of companies announcing increased dividends or share buybacks, that is not always evident. Japanese equities are still trading on the back of sentiment and market themes, leaving a large part of the market deeply undervalued.
As active managers, we take advantage of this disparity in the market. With record low valuations and sizeable upside potential for many quality companies, Japanese equities are proving to be a credible asset class for those investors with medium-term time horizons. If investors look past the tweets that can sway market sentiment on a weekly basis, it is possible to find solid investment opportunities in the world’s second largest equity market.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.