It all started in 2012 with Shinzo Abe’s economic legacy, coined Abenomics. The first two arrows – monetary policy and increased government spending, were quick to implement while early signs of the third – economic structural reform – were starting to emerge. At AVI, it seemed the right time to seize the opportunity in Japan.
By the beginning of 2019 it was evident that the Corporate Governance Code was having a marked impact on the behaviour of companies and shareholders in Japan. Attitudes towards balance sheet efficiency, operating efficiency and shareholder returns were shifting. We began to see an increase in the quantum and success of shareholder activism. During the 2019 AGM season, a record 54 companies received shareholder proposals, 28% more than the previous year.
Private Equity joins the Party
This new shareholder activism in Japan came to the attention of private equity funds and by the end of 2019 large global private equity players were showing their enthusiasm for Japan. For some time, they had been aware of Japan’s abundance of excess balance sheet cash, potential for margin improvement, and cheap financing; however, the changing corporate governance environment was prompting renewed interest. KKR, Apollo, Blackstone, Bain, Carlyle and Permira had offices or were quickly opening offices in Japan.
This trend was encouraging especially as the type of companies AJOT held were ripe for acquisition. Companies with no debt, copious excess cash and consistent free cash flow generation. AJOT benefitted from its first takeover transaction when Nitto FC was taken private at a +38% premium by a private equity firm.
The Unexpected: COVID-19
The outbreak of COVID-19 and the related lockdowns led to a broad sell-off in global assets. There were few safe havens, and although Japan experienced a lower infection rate than Western countries, Japanese equities suffered, nonetheless. The severe economic shock from an unforeseen event like COVID-19 highlights the advantages of investing in resilient companies with solid balance sheets. While in the short-term factors might weigh on performance, we were confident that our companies were well positioned for a recovery.
The second quarter of 2020 saw a strong recovery in equity markets, as fears of a prolonged shutdown from the COVID-19 outbreak receded. However, 2020 was not an easy year for our strategy as it stifled our engagement activity and portfolio companies took a more cautious stance on reform. We proceeded, despite restrictions on travel, with our public campaign on Fujitec, a global manufacturer of elevators and escalators. We launched a website highlighting a multitude of issues ranging from low margins, poor shareholder returns to manufacturing inefficiencies.
Governmental and Regulatory Bodies on Side
Throughout this period the message from the governmental and regulatory bodies was clear – they will keep ratcheting up guidelines and regulation to ensure reform continues. The Financial Service Agency, METI (Ministry of Economy, Trade and Industry) and the TSE (Tokyo Stock Exchange) were seemingly aligned on supporting corporate reform and shareholder engagement. This pressure from
the government and regulatory bodies continued when the TSE announced that shares held by domestic banks and insurance companies would be excluded from its free float calculation. This was a direct attack on Japan’s allegiant shareholder problem and created more opportunity to engage with some of our portfolio companies on unwinding cross-shareholdings.
In 2020 PM Shinzo Abe resigned due to ill health, but his successors, Yoshihide Suga then Fumio Kishida in 2021, continued Abe’s reform agenda. The corporate reform arrow had already been launched and changes in politicians would not deter it.
By 2021 an updated Corporate Governance Code was released. The most salient points were the ones focused on independent directors with pertinent skills and the requirement for listed subsidiaries to oversee conflicts of interest. This scrutiny on listed subsidiaries was positive for AJOT as we had exposure to six listed subsidiaries at that time.
In 2023, the TSE followed through on their announcement calling on companies to address low valuations. This was mostly aimed at the 1,800 companies in Japan that trade on a price-to-book ratio of less than 1x. It was an encouraging step, highlighting that regulators are continuing to use their powers to promote reform. Then later in the year METI published its “Guidelines for Corporate Takeover”. The guidelines contained encouraging wording and we made our first tender offer to a portfolio company, seeking to take a minority stake. The option of putting forward tender offers won’t be an appropriate strategy for all our holdings, but we believe the environment has evolved in such a way that unsolicited tenders can now become a valuable tool to add to our engagement repertoire.
Looking back over the past five years, we launched 10 public campaigns and numerous more private engagement campaigns. We submitted 14 shareholder proposals, created 10 campaign webpages, wrote over 100 letters to managements and Boards and held nearly 500 meetings. The responses have for the most part been accepting, and increasingly so with companies becoming more aware of their responsibilities to shareholders.
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The Carrot or the Stick
Although most of our engagement was private, our public campaigns helped to add pressure to both the companies being targeted and our other portfolio companies. Overall, our public campaigns – which some might perceive as aggressive in their demands – have enabled us to deepen the relationship with our portfolio companies. We believe by focusing on a whole suite of issues, not just capital efficiency, and basing our arguments on the principles of the Corporate Governance Code, it has been harder for management to push back against our suggestions. The intent of our campaigns was to raise awareness of issues weighing on the share price, force management to discuss them, and encourage other shareholders to pressure management to rectify them.
The Macro Environment
We are optimistic about the macro environment in Japan. The weak Yen makes Japan highly cost-competitive, both for tourism and manufacturing. Inflation has continued to creep higher having returned after a 30-year absence and with wage growth and increased spending, we see a more rational allocation of capital and improved productivity. This bodes well for the companies we invest in. The Bank of Japan (BOJ) expansionary monetary policy over the past five years has weighed heavily on the Yen, which on an effective real exchange rate basis is at the cheapest since the early 70s. Even a small adjustment in monetary policy could lead to a stronger Yen. This could be a driver for attractive absolute returns.
Case Study: Challenges
SK Kaken, a manufacturer of construction coating paints, has been in the portfolio since inception, generating a return on investment of -23% with an IRR of -6%. Our proactive engagement with SK Kaken management has broadly focused on capital allocation and liquidity enhancement, corporate governance, and shareholder communications. AVI has consecutively submitted shareholder proposals at the three most recent AGMs. At the latest AGM, we sought to return the excess cash being hoarded on the balance sheet back to shareholders via dividends as well as the cancellation of treasury shares. We achieved majority support from minority shareholders; however, the resolutions were not passed due to the founding families significant ownership stake.
More positively, despite the founding Fujii Family holding more than 40% of the votes, management recently completed a 5-for-1 stock split, have reduced director tenure, transitioned to a company with an audit & supervisory committee, increased board independence, and improved disclosure of ESG performance and quarterly results. Although we are pleased that management have implemented some of our suggestions, there is a long way to go with SK Kaken still trading on a derisory EV/EBIT multiple of 0.3x, compared to its peer group average of 8.4x.
Case Study: Successes
Fujitec, an elevator installation and maintenance company, was a near five year holding since inception in October 2018, generating a return on investment of +111% and an IRR of +32%. We engaged extensively with Fujitec management on several areas, including operational improvements, capital allocation, corporate governance, and shareholder communications.
In early 2020, having been a shareholder for more than a year and having received a lacklustre response from management to the three letters we had sent thus far, our engagement turned public as we launched the AVI campaign website ‘Taking Fujitec to the next level’. This prompted a more pragmatic response from management, as Fujitec announced its future strategic direction plan and later revised its Vision24 min-term plan after AVI threatened another public presentation and accompanying press release.
Overall, despite early resistance, management responded positively to our suggestions, announcing a share buyback program, reorganising the board to be majority independent, and providing full English translation of results. As a result, Fujitec’s EV/EBIT valuation multiple increased from 6x to 20x over our investment period.
A famous Japanese proverb is an apt one, “fall seven times and stand up eight”. We can write numerous letters and presentations to management and boards of companies before receiving a positive response, but perseverance pays off. The environment has become more supportive for our approach, and we remain convinced that our strategy is effective. The opportunity in our portfolio to outperform is impressive and we see the developments over the past five years as a strong tailwind to propel us forward.
This article was written by AVI Japan Opportunity Trust (AJOT)
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courtesy of Markus Spiske on Pexels
In a historic turn of events, the 28th Conference of the Parties (COP) concluded with a groundbreaking agreement to “transition away from fossil fuels.” This marks the first time such an explicit commitment has been incorporated into the final agreement at a COP. However, despite this unprecedented move, some nations advocated for more robust commitments, raising concerns about potential loopholes in the finalised language.
The decisive statement read: “Transitioning away from fossil fuels in energy systems, in a just, orderly and equitable manner, accelerating action in this critical decade, so as to achieve net zero by 2050 in keeping with the science.”
In addition to the overarching agreement, several world leaders pledged commitments designed to accelerate progress toward achieving the 1.5°C target established during the 2015 COP21, also known as the Paris Agreement.
This landmark accord, signed by 196 parties, aims to restrict the rise in global average temperature to 1.5°C above pre-industrial levels by the end of the century. Notable commitments from COP28 include:
Renewable Energy Surge: 130 nations pledged to triple global installed renewable energy generation capacity to at least 11,000 GW by 2030. Concurrently, they committed to doubling the annual rate of energy efficiency improvements from 2% to 4% each year until 2030.
Cooling Emission Reduction: 67 nations vowed to collaboratively reduce cooling-related emissions across all sectors by at least 68% relative to 2022 levels by 2050.
Nuclear Energy Expansion: 22 nations signed the Declaration to Triple Nuclear Energy, aiming to triple global capacity by 2050.
Oil & Gas Industry Commitment: 50 fossil fuel producers endorsed the Oil & Gas Decarbonisation Charter, voluntarily agreeing to cease flaring excess gas by 2030 and eliminate leaks of methane, a potent greenhouse gas.
Sustainable Agriculture and Food Systems: 153 nations committed to the Declaration on Sustainable Agriculture, Resilient Food Systems, and Climate Action, recognising the need to address the impact of food production and land-use changes on carbon emissions.
Despite these additional pledges, the International Energy Agency (IEA) tempered optimism by calculating that the full implementation of COP28 measures would merely narrow the emissions gap related to energy consumption by one third by 2030, in comparison to the existing trajectory towards a 1.5°C scenario. The Financial Times quoted Fatih Birol, CEO of the IEA as saying: “It is good, but it is not good enough.”
While global progress continues towards decarbonisation and a shift away from fossil fuels, meeting legally binding targets necessitates significant strides forward and bold policy developments that have yet to materialise. The challenge ahead lies in turning commitments into concrete action to ensure a sustainable and climate-resilient future for generations to come.
Max Gilbert is an investment director at Gravis.
Header image: courtesy of Pixabay on Pexels
When Luiz Inacio Lula da Silva won the Brazilian presidential election there were high hopes that he would address the issue of the destruction of the Amazon rainforest, preferably to halt it.
It is hard to get one’s head round the extent of the destruction of the rainforest.
According to the Brazilian Space Research Institute (INPE), 1,455 square kilometres (562 square miles) of rainforest were destroyed in September 2022 – an area almost twice the size of New York City. The previous record was for September 2019 when 1,454 km2 were destroyed.
So COP27 in Egypt coming so soon after the Election presented a perfect time for Lula da Silva to honour the commitment Brazil had made to end deforestation by 2030.
And he appeared to be on track to do that.
Lula da Silva told delegates he would end the illegal deforestation and went so far as to say he was to ask the United Nations to host the COP30 summit in 2025 in the Amazon rainforest.
According to the Financial Times Lula da Silva said: “It’s important for it to be in the Amazon. It’s important for the people who defend the Amazon to get to know what the region is. We will fight hard against illegal deforestation. We will take care of indigenous people.”
“This devastation [of the Amazon] will be a thing of the past. The crimes that happened during the current government will now be combated,” Lula said, “We will rebuild our enforcement capabilities and monitoring systems that were dismantled during the past four years.”
It is to be hoped that the news will encourage other countries to help and re-visit for example, The Amazon Fund – a forest preservation alliance set up to raise donations for non-reimbursable investments to prevent, monitor and combat deforestation and promote the preservation and sustainable use in the Brazilian Amazon.
At COP27 Germany and Norway indicated they were willing to restart payments to the fund which had been halted in 2019 due to the attitude of the then Brazilian Bolsonaro government.
It is not just the Amazon rainforest that needs protecting; encouragingly COP27 had news on other fronts. The European Union (EU) announced a 25.5 million euro investment in the protection and sustainable use of the Five Great Forests of Mesoamerica, which range from Mexico through Belize, Guatemala, El Salvador, Honduras, Nicaragua, Costa Rica, and Panama, covering an area of over 120,000 square kilometres.
Here in the UK, we would be wise not to rest too much on our laurels. According to the Woodland Trust: ‘Irreplaceable ancient woods continue to be lost and damaged by house building, new roads and railways. Over 1,225 ancient woods across the UK are under threat from development while during the last 21 years at least 981 have been permanently lost or damaged. More insidious threats facing woods and trees include unseen reactive nitrogen air pollution from agriculture which strips trees of their layer of protective lichens and causes a fertiliser effect where grasses out-compete more delicate woodland flowers. This disrupts woodland ecosystems in ways we are only beginning to understand.’
The State of Nature 2019 report showed that “the abundance and distribution of the UK’s species has, on average, declined since 1970 and many metrics suggest this decline has continued in the most recent decade. There has been no let-up in the net loss of nature in the UK.” Key pressures on the UK’s biodiversity were found to be agricultural management; climate change; pollution and urbanisation (among others).
Here – and globally there are steps being taken to address the threat to biodiversity, including the imminent UN biodiversity conference COP15, belatedly taking place in Montreal in December, the theme of which is “Ecological Civilization: Building a Shared Future for All Life on Earth”.
There are other initiatives such as the Partnership for Biodiversity Accounting Financials (PBAF) which are helping the financial industry to “transparently assess and disclose their impact and dependency on biodiversity”. Currently it numbers 40 financial institutions (including some of our clients) with assets over $9trn. The independent foundation, based in the Netherlands notes that: “Through their investments, financial institutions can play an important role in the conservation and sustainable use of biodiversity, contributing not only to the biodiversity targets of the Convention on Biological Diversity (CBD), but also to the reduction of investment risks. For financial institutions to take up this role, the availability of science based, reliable data on the impacts on biodiversity is an important precondition.”
It might not take long to fell swathes of forests and woodland, but it will for new ones planted to grow. And what will be lost while generations wait for that to happen?