Although many countries are now taking initial steps towards relaxing their COVID-19 containment policies, the lack of any clear end in sight means that there is still no way to determine when economic activity might return to pre-pandemic levels. We are only now starting to understand the extent of the economic damage inflicted by the coronavirus. 

We have identified a number of long-term investment themes, based on goods and services that are necessary and difficult to substitute. In many cases, these longer-term secular themes were already much in evidence before the coronavirus ripped through the world economy. In some cases, the pandemic has accelerated these long-term trends, potentially turbocharging demand for products such as superior air ventilation technology, digital payment systems, and office automation.

Focusing on high sustainable ROE (Return on Equity)
This crisis has highlighted the power of investing in stocks with high and sustainable ROE, which equates to investing in strong businesses that are able to excel across economic cycles. Investors have shown a preference for quality companies with high margins, strong balance sheets and cutting-edge innovation that can deliver performance consistently. 

However, it is also essential to analyse where that high ROE comes from. For example, many major US companies have lifted their ROE through share buybacks in recent years, sometimes to an excessive degree. In some cases, the resulting diminished cash balances have driven some of these companies to seek external support when the pandemic hit their businesses. Similarly, in Japan, cash-rich companies have been under pressure to increase returns to their shareholders, although most have been more conservative in response to these demands. This supports our view that investing in Japanese companies with high and sustainable ROE remains a solid long-term investment proposition. “Sustainable” is the key word here – these companies are backed by their fundamental strength and growth, while they have an appropriate degree of financial leverage, 

Investment themes
In addition to ROE, our investment process also looks at specific investment themes that are sometimes unique to the Japanese corporate sector. One of these themes is air ventilation technology: Japan is home to some of Asia’s leading air conditioner producers. The best of these have responded proactively to the coronavirus crisis by launching initiatives to reduce fixed costs and improve operational efficiency through the use of artificial intelligence and IoT (Internet of Things). Innovations such as energy-efficient air conditioners with automatic interior cleaning functions keep them ahead of the competition. 

Concerns such as indoor air quality will take on a renewed importance in a post pandemic world, so these companies are responding to this new air quality demand with equipment that can combine air purification and ventilation with auto cleaning and disinfection. They have responded quickly to potential opportunities in providing antibacterial ventilation equipment for pharmaceutical production facilities and hospitals, while expanding their sales of air purifiers. 

Belated digital transformation of payment systems 
Japan also has its local champions in business sectors such as payment services for e-commerce and credit card transactions. The leaders in this sector are well on their way to becoming core components within the country’s electronic payments infrastructure.

Leading companies have benefited from growth of online shopping and digital content, and more recently from a surge in demand from smaller businesses shifting to online business models during the state of emergency. Japan is still a largely cash-dominated society in spite of its high-tech industries. The government has been pushing for a shift towards cashless transactions, and even introduced incentive programmes as the consumption tax was raised to 10 per cent from 8 per cent in October 2019. With businesses launching their own mobile payment facilities, leaders in the payment processing systems sector are able to benefit from these new entrants. These payment systems also have to be integrated with Japan’s idiosyncratic banking system, giving the major local players an advantage over potential foreign rivals in supporting common platforms both for Japan’s major financial institutions as well as its fragmented regional banking system. 

Office automation: adapted to their environment
It is often a surprise to visitors unfamiliar with the office environment in Tokyo that fax machines are still in widespread use. The incongruent presence of cutting edge automated production systems alongside legacy administrative systems offers a huge potential for the best Enterprise Resource Planning (ERP) vendors. The leading suppliers in this industry also enjoy excellent profit margins.

One outcome of the pandemic has been the wider acceptance of remote working in traditional organisations, as well as the deployment of technologies to improve administrative efficiency and reduce costs. These companies are seeking to modernise corporate Japan from its often anachronistic workplace culture dominated by face-to-face meetings and paper documents by using automated solutions.

Haircare: everyday product from agile companies 
Japan’s competitive and well-managed companies are not just found in the technology related sectors. Japan also has some leading providers of high quality haircare products for professional beauty salons in Japan and the rest of Asia. The best of these companies have achieved strong growth by providing support to salons, and their strong networks enabled them to work with prominent hair stylists to develop innovative hair products. 

Coronavirus lockdown policies have been especially disruptive to the personal care services sector, not just in Japan but worldwide, as businesses such as salons were ordered or requested to close completely. As the world steps out of lockdown, we expect to see a strong recovery for haircare services due to pent up demand. Companies that can carve out a strong niche in service sectors can offer just as much investment potential as the technology leaders.

Small business M&A consultancy: drawing on the legacy 
Japan’s business environment with its thousands of small and medium size enterprises (SME), many of which are still family controlled after multiple generations, now offers a unique opportunity for specialist merger and acquisition (M&A) intermediary firms. Japan faces challenging demographics, with the average age of these SME owners rising to 69 from 47 over the past 23 years. Consultancies in this sector can handle hundreds of transaction a year and play a crucial role in ensuring the continuity of businesses by addressing their succession problems. The coronavirus impact has also worsened the cash flow situation for some smaller companies, increasing potential transaction volumes and reducing asking prices. This presents an opportunity for buyers and intermediaries by increasing the potential for M&A activity in the SME sector.