As Japan’s domestic investor base returns to its local market by increasing their allocation to Japanese equities after two decades of hibernation, these efficient capital allocators, these permanent start-ups, are a part of the investible universe which is winning attention.

The following article takes a break – for which the editors are deeply grateful – from the 24/7 coronavirus coverage to delve into the details of Japanese companies’ prospects and characteristics. Japan has in recent years sought to loosen up some of the corporate governance rules in order to give the economy a supply-side kick. There have been a few false dawns for Japanese equities in past years – it will be interesting to see how the market fares in future. 

The author of this article is Richard Kaye, portfolio manager of the Comgest Growth Japan fund. The editors are pleased to share these views and invite responses. The usual editorial disclosures apply. Email tom.burroughes@wealthbriefing.com and jackie.bennion@clearviewpublishing.com

Japan is the home of the world’s oldest companies and boasts one of the highest concentrations of large family-run businesses on the planet. At the start of the 21st century, one third of all Japanese listed companies had some kind of family control and that remains the case today. 

Japan’s tendency to corporate family ownership can be explained by its relatively recent industrialisation. First, an industrial and service infrastructure of family companies sprang up alongside and became symbiotic with the state-affiliated enterprises which pushed the country into economic modernity. Second, Japan’s economic miracle of the 1970s is so recent that many founders from that era are still in charge. 

Investors should pay close attention to these businesses, perhaps more than they do at present. We have observed many cases globally where family or founder-owned or run companies align well with shareholders’ interests, and in Comgest’s Japan portfolio we take that idea quite far. About one third of our holdings and, in our opinion much of the fund’s long-term outperformance, is from companies which fit that definition. Some examples are Fast Retailing, Hikari Tsushin, Nidec, Keyence, Softbank, Pan Pacific, Nihon M&A, Hoya, Obic, Zozo, Peptidream, Kobe Bussan and Sushiro.

Simply put, we view these companies as having a “Day Zero” mentality which translates naturally to capital discipline with a long-term mindset, through the pursuit of unique businesses. These are start-ups which grew old. They speak the language of the shareholders because they are run by a major shareholder. With not just skin, but blood sweat and tears in the game, they certainly seek returns but importantly, they also seek long-term survival. They are the original ‘ESG’ players before ESG existed; they fulfil a sustainable social role and their capital allocation choices have rewarded our trust.

Hoya Corporation, which has parried its core strength in glass processing into near dominance in disc substrates and semiconductor imaging materials, is a classic case. This family glassware business gained national renown from supplying US occupation authority buildings. The company’s willingness to divest its legacy crystal ware business and the camera business, to which many Japanese companies are unprofitably wedded, or to build a contact lens retail network in Japan which draws on Hoya’s ophthalmic presence but sells other companies’ lenses because that is more profitable, all reflect this flexibility and almost ruthless pursuit of return. When we asked owner and founder President Suzuki which businesses he keeps and why, his answers were as if from a textbook: ‘the company is not mine; any business can grow old and we constantly need to consider divesting’. The words are not from a book, though; they express how he really thinks at the interstices of his organisation. 

Hoya’s idiosyncrasy in pursuing return and transparency manifests itself also in the fact that another family member regularly opposes the management at AGMs. As Mr Suzuki has hinted wryly, a Hegelian dialectical approach to discussion has led to great decisions, but long and difficult meetings.

Another company, Hikari Tsushin, a dominant office supplies provider for Japan’s tangled web of micro companies has a similarly unemotional approach to capital discipline, which reflects chairman Shigeta’s focus as a 52 per cent shareholder. Its preferred expression of this approach is Subscriber Acquisition Cost (SAC) yield, and across its business lines of telephone contracts, water servers, photocopiers and customer database systems it has transparent metrics for lifetime contract value, churn and return. It agilely quits low-return projects, like fibre optic resell where the regulator effectively stymied its room for manoeuvre and candidly recognises mistakes such as its internet investment twenty years ago or its development of a life insurance agency. It continually incubates small affiliate companies where it gradually takes a larger stake and has a constant pipeline of new and high SAC-yield projects which fit the changing needs of its client landscape.

Obic is one of Japan’s leading business software providers and the country’s answer to Oracle for small companies. Since its creation in 1968 by Masahiro Noda, (who remains Chairman and 23 per cent holder) it has insisted on keeping all operations home-grown: no sales agents, no mid-career hires. “We are like the Chairman’s children,” say Obic staff. That may sound odd in the West, but it has created a consistent and reliable service provider in corporate Japan which is heading Japan’s software solutions to address its labour shortage.

Similarly to Obic, Nihon M&A Center is an indispensable presence among small Japanese companies but as a succession advisory firm, it is suffused with the founder culture of 12 per cent holders Mssrs Miyake and Wakebayashi. Nihon differs from Obic in its openness to outside talent but shares with Hikari Tsushin that ruthless focus on capital return, efficiency of process and gross profit per employee, traits one would associate with a shareholder-managed company. Just recently we spoke with Mr Miyake, and he explained how he regularly sells stock to colleagues to bind them more directly into the destiny of the company.

These firms are not the sleepy, hidebound companies one might unkindly expect based on their ownership structure. Rather, as Japan’s domestic investor base returns to its local market by increasing their allocation to Japanese equities after two decades of hibernation, these efficient capital allocators, these permanent start-ups, are a part of the investable universe which is naturally winning attention. Comgest is pitching its tent there, too.