Japan’s “Show Me the Money” Corporate Governance

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Los márgenes empresariales se disparan en las compañías japonesas
Photo: Moyan Brenn. Japan's "Show Me the Money" Corporate Governance

The fact that due to the encouragement of the Abe Administration, Japanese corporations are strongly emphasizing profitability is extremely important to investors in Japanese equities. This is “icing on the cake” of the “Show Me the Money” corporate governance improvement that we have long-highlighted in our thought leadership effort on Japan. Indeed, while increasing the number of independent directors and other recent governance issues are very important in the intermediate term for Japan, it is crucial for investors to understand that much of the profitability message has actually been understood by Japanese corporates for a decade. This is shown by the divergence in the profit margins from the trend in GDP growth in the chart below, showing that even though GDP growth has remained quite subdued, profit margins have surged.

Since the Koizumi era, Japan has embarked on major rationalizations in most industries, with the number of players often reduced from seven down to three. The fruits of this restructuring were slower to ripen than in Western world examples, and they were hidden by a series of crises (the Lehman shock, the turbulence in China, the strong Yen and of course, the Tohoku crisis), but since Abenomics began, the global backdrop for Japan has been stable and there have been no domestic crises, thus allowing the fruits to ripen.

The CY2Q15 data on overall corporate profits (not just of listed companies) recently announced continues this upward trend, showing that the pretax profit margin’s four-quarter average hit a new high of 5.26%. We expect that profit margins will expand further in coming quarters, driven by continued industry rationalizations and cost-cutting. It is also worth mentioning that forex related profits are not the only driver of this improvement, as the profit margin of services industries also surged to a new record high, as shown in the second chart below.

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Of course, this improving structural profitability trend has become more fully realized by global investors, but there remain a decent number of Japan-skeptics, and 2Q profit margins surged so much that this dwindling group should reduce their remaining doubts; and thus, there is a significant amount of overseas capital that can still flow into Japanese equities.

Conclusions

  • Years of corporate restructuring’s progress was hidden due to successive global and domestic crises.
  • “Show me the Money!” corporate governance: Japanese companies care even more now about corporate profitability.
  • The dividend paid by TOPIX is surging upward and we expect it to double in the five years from 2013 through 2018.
  • On top of the corporate tax cut in April, Abenomics is having a strongly positive effect on profits due to the normalized Yen and further deregulation should gradually push profit margins higher.
  • Poor demographics are linked with GDP growth, but countries with strong automation and efficiency capabilities can completely offset such (see our report on Debunking Demographics). As these charts show, even if Nominal GDP growth is fairly flat, corporate profits can rise sharply in Japan due to productivity increases and gearing to global growth via multinationalization.

Opinion column by John Vail, Chief Global Strategist at Nikko AM

Japan’s “Show Me the Money” Corporate Governance

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Cinco razones que explican por qué los beneficios empresariales de Japón van a seguir creciendo
CC-BY-SA-2.0, FlickrPhoto: L'Ubuesque Boîte à Savon . Japan's "Show Me the Money" Corporate Governance

Given the 4th quarter slowdown in the global economy, it is no surprise that overall corporate profit margins in Japan decelerated during that period. But before one panics and says that they are about to plummet, one should realize that it would likely require a global recession for such to occur and that the 2005-2007 period showed that profit margins can plateau at a high level for an extended period of time. Indeed, the four quarter average is still creeping upward to new record levels, and like most of the rest of the world, the manufacturing sector is declining while the non-manufacturing sector is accelerating to record highs. Meanwhile, Japanese profits are performing much better than those in the US or Europe. We have covered the reasons for such in our recent piece The Japanese Equity Outlook After the Nasty New Year Start, but let us emphasize herein the corporate governance aspect of that piece.

The fact remains that, partially due to the encouragement of the Abe administration, Japanese corporations are continuing their structural shift towards improving profitability. This is “icing on the cake” of the “Show Me the Money” corporate governance improvement that we have long-highlighted in our thought leadership effort on Japan. Indeed, while increasing the number of independent directors and other recent governance issues are very important in the intermediate term for Japan, it is crucial for investors to understand that much of the profitability message has actually been understood by Japanese corporates for a decade. This is shown by the divergence in the profit margins from the trend in GDP growth in the chart below, showing that even though GDP growth has remained subdued, profit margins have surged.

Since the Koizumi era, Japan has embarked on major rationalizations in most industries, with the number of players often reduced from seven down to three. The fruits of this restructuring were slower to ripen than in Western world examples, and they were hidden by a series of crises (the Lehman shock, the turbulence in China, the strong Yen and of course, the Tohoku crisis), but since Abenomics began, the global backdrop for Japan has been stable and there have been no domestic crises, thus allowing the fruits to ripen.

The CY4Q15 data on overall corporate profits (not just of listed companies) recently announced unsurprisingly shows some flattening of this upward trend, with pretax profit margin’s four-quarter average hitting the slightly higher new record level of 5.36%. We expect that profit margins will flatten in coming quarters, partially driven by continued industry rationalizations and cost-cutting, but also negatively impacted by the stronger Yen. As mentioned above, the profit margin of services industries also surged to a new record high, as shown in the second chart below.
 

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One should also note that Ministry of Finance statistics do not cover post-tax income, and due to recent corporate tax cuts, the overall net profit margin is likely expanding significantly.

Conclusions

  1. Japan’s overall corporate profit margin is unlikely to reverse soon on a four-quarter basis, while we believe the service sector will remain strong.
  2. “Show Me the Money!” corporate governance: partly due to Abenomics, Japanese companies care even more now about corporate profitability and shareholder returns.
  3. The dividend paid by TOPIX is surging upward and we expect it to double in the five years from 2013 through 2018.
  4. Poor demographics can be linked with poor GDP growth, but countries like Japan with strong automation and efficiency capabilities will likely continue to completely offset this factor (see our report on Debunking Demographics).
  5. As these charts show, even if Nominal GDP growth is fairly subdued, corporate profits can rise sharply in Japan due to productivity increases and gearing to global growth via multinationalization. Thus, weak domestic GDP statistics should not concern investors much. Indeed, normally, the service sector would be hurt the most by weak domestic GDP in a typical country, but Japan’s services sector profitability has been very strong despite weak GDP and we expect such to continue, which should assuage investors’ fears to a large degree.

John Vail is Nikko AM’s Head of Global Macro Strategy and Asset Allocation.

China: Real or Imagined Economic Improvement?

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¿Podrá la Fed adoptar una política monetaria completamente diferente a la del BCE y el Banco de Japón y resistir a la presión que llega desde China?
CC-BY-SA-2.0, FlickrPhoto: Billie Ward. China: Real or Imagined Economic Improvement?

The ‘lower for longer’ environment that we are experiencing has required central banks to adopt some extraordinary measures. Most recently the Bank of Japan adopted negative interest rates and the European Central Bank pulled multiple levers including cutting the depo rate by 0.1%, increasing quantitative easing and opening it up to non-financial corporate bonds, as well as introducing a new series of four-year targeted long-term refinancing operations (TLTROs). These measures, along with an upswing in corporate profitability and growing signs of stability in credit markets, have helped provide a backdrop against which risk assets look more benign. They have certainly resulted in a wild ride for banks.

Our view is that, in Europe at least, the ECB measures are probably a net positive for bank earnings and banking pressures should diminish from here; but market sentiment is still ‘see-sawing’ between confidence that central banks absolutely have enough in their policy toolkits to avert deflationary pressures and stimulate growth, and fears that those toolkits do not have a lot left in them – as seen by initial reactions to the ECB closing the door on further rate cuts.

In the US, a host of market participants had been circulating expectations that the US could be heading into recession this year, but economic data has begun to turn, with very strong US employment data in particular coming hot on the heels of other economic surprises, helping to ease financial conditions. But we must bring China in here. As China-watchers, we are trying to interpret whether the recent improvement in sentiment is backed up by real or imagined economic improvement. Clearly, none of the structural issues we have identified previously appears to have been addressed: the central bank is targeting a 6-6.5% growth rate this year and the liquidity taps have been turned on but, ultimately, we believe China is experiencing a cyclical rather than a structural improvement as the PBoC tries to ease the pace at which economic growth decelerates. For the US, the key question is one of divergence: is the Fed able to adopt monetary policy that diverges from ECB and Bank of Japan actions and operates independently of spillover pressure from the China slowdown? We believe the US dollar is ready for another leg-up, but it needs a catalyst such as the Fed raising rates – that may not happen until June.

Brexit uncertainties persist. The online polls seem unambiguously to be coming out in favour of leave, whereas the phone polls are unambiguously favouring remain – by a wide margin. Central establishment figures have entrenched themselves on both sides of the debate but this has not lessened the uncertainty, that is only intensifying as we move closer to the 23 June referendum. Sterling has been the main mover in this, with market forecasts indicating 1.50 against the dollar is the appropriate valuation for remain and 1.20 an appropriate valuation for leave. As the polls change, so Sterling gets battered about. How markets change in the run-up to the referendum will be interesting. The uncertainty is putting ever more distance between the Bank of England moving interest rates – despite relatively good labour market numbers – with our valuation research indicating the first rate rise in April 2019, though some analysts have pushed that back to 2020.

Mark Burgess is CIO EMEA and Global Head of Equities at Columbia Threadneedle.

 

M&G’s Claudia Calich to attend Miami Summit

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Claudia Calich, fund manager de M&G Investments, repasará la actualidad de los mercados emergentes en el Fund Selector Summit de Miami
CC-BY-SA-2.0, FlickrPhoto: Claudia Calich, fund manager at M&G Investments. M&G’s Claudia Calich to attend Miami Summit

Claudia Calich, fund manager at M&G Investments will outline her view on where to find pockets of value in emerging markets debt assets, when she takes part in the Funds Society Fund Selector Summit Miami 2016.

Currently, emerging market investors face uncertainty from factors such as slower economic growth in China, volatile oil prices and geopolitical risk. Calich suggests flexibility in strategies such as the M&G Emerging Markets Bond fund facilitate taking high conviction positions without being constrained by local or hard currency, or differences between government and corporate bonds.

Outlining the opportunities, Calish will also explain her currency and interest rate positioning.

Calich joined M&G in October 2013 as a specialist in emerging markets debt and was appointed fund manager of the M&G Emerging Markets Bond fund in December 2013. She was also appointed acting fund manager of the M&G Global Government Bond fund and acting deputy fund manager of the M&G Global Macro Bond fund in July 2015. Claudia has over 20 years of experience in emerging markets, most recently as a senior portfolio manager at Invesco in New York, with previous positions at Oppenheimer Funds, Fuji Bank, Standard & Poor’s and Reuters. Claudia graduated with a BA honours in economics from Susquehanna University in 1989 and holds an MA in international economics from the International University of Japan in Niigata.

 

Janus Capital Names President, Head Of Investments

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Janus Capital nombra a Enrique Chang como nuevo CIO de la firma
Photo: Enrique Chang. Janus Capital Names President, Head Of Investments

Janus Capital has promoted Enrique Chang to the position of president, head of Investments.

Chang took up his new duties on 1 April, overseeing Janus’ fundamental and macro fixed income teams, in addition to his existing leadership responsibilities of the Janus equity and asset allocation investment teams.

“The decision to promote Enrique to president, head of Investments, is reflective of his increased responsibility in now overseeing the majority of our Janus investment teams, as well as his significant contributions to the firm over the past two and a half years,” said Dick Weil, CEO of Janus Capital Group.

Chang will partner with CEO Dick Weil and president Bruce Koepfgen.

Janus Capital specified that Perkins Investment Management and Intech Investment Management will continue to report into their respective leadership teams and relevant boards.

Chang was previously CIO Equities and Asset Allocation. He joined Janus in September 2013 and was previously executive vice president and chief investment officer for American Century Investments, where he was responsible for the firm’s fixed income, quantitative equity, asset allocation, US value equity, US growth equity and global and non-US equity disciplines.

At end December 2015, Janus Capital’s AUM reached around $192.3bn (€169.2bn).

Santander México Hires Jorge Arturo Arce for its Global Corporate Banking Division

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Santander ficha a Jorge Arturo Arce Gama para Global Corporate Banking en México
. Santander México Hires Jorge Arturo Arce for its Global Corporate Banking Division

Grupo Financiero Santander México,  (BMV: SANMEX; NYSE: BSMX) (“Santander México”), one of the leading financial groups in Mexico, announced that Jorge Arturo Arce Gama has been hired as Deputy General Director of Global Corporate Banking.

Executive President and CEO of Santander México, Héctor Grisi Checa, said, “Santander México is bolstering its leadership in corporate banking, and securing an executive of Jorge’s caliber underscores our commitment to this goal. We are attracting the best talent and forming the most powerful unit in this segment of banking in Mexico, a clear differentiator from our competitors.”

Jorge Arturo Arce Gama is an industry veteran, with more than 25 years of experience in investment and corporate banking. He most recently served as CEO and Chairman of the Board of Deutsche Bank México. He has worked at institutions including Citibank México and Deutsche Bank in New York with responsibility for Latin America. He has also been Vice President of the Mexican Banking Association (ABM for its initials in Spanish) and a member of the Business Coordinating Council.

Juan Garrido will be moving to the UK.

Boring Can Be Beautiful

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Aburrirse puede ser bueno
CC-BY-SA-2.0, FlickrPhoto: Harold Navarro. Boring Can Be Beautiful

While it’s easy to get caught up in campaign season — whether in the United States, where raucous primaries are underway, or in the United Kingdom, where the Brexit campaign is in full swing — that probably won’t help you make investment decisions.  It’s probably better to see what’s going on inside some of the world’s biggest economies.

 The US economy ebbs and flows, but the real average growth rate for this business cycle —after adjusting for inflation—has been about 2%. And we’re slogging along at about that pace as we begin the second quarter despite repeated, and so far unfounded, concerns that the economy is headed for a recession.

Here’s a look at the US economic scorecard for March:

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Looking around the world, China remains weak, but economic data is no longer worsening. There is still a lot of excess capacity, but fears of a deep recession have faded somewhat.

We have seen manufacturing weakness in the eurozone amid headwinds from slowing exports to emerging markets.  Inflation has remained scant, prompting the European Central Bank to push interest rates deeper into negative territory and adopt additional unconventional monetary policy tools. Consumption is a bright spot, boosting companies that cater to consumers. We expect a real economic growth rate of slightly better than 1% in 2016.

Japanese growth continues to hover near zero. Despite negative interest rates, fiscal stimulus and structural reforms, Abenomics has not proven sufficient to rekindle growth.

Few signs of excess

We follow a number of business cycle indicators for signs that the present US expansion may be continuing, or conversely, coming to an end. Of these indicators, half are flashing signs that excesses may be creeping into the economy while the other half are showing no signs of stress. Several areas of concern have shown modest improvement of late. For instance, there have been tentative signs of improvement in the Chinese manufacturing sector, and oil prices, which until recently had wreaked havoc with corporate profits, have stabilized to some degree.

While US growth may seem boring, there are some intriguing phenomena going on in other parts of the world. Perhaps the most interesting — some would say crazy — phenomenon is the adoption of a negative interest rate policy (NIRP) by the European Central Bank, Bank of Japan and other central banks. About 40% of the sovereign debt issued by eurozone governments today trades with a negative yield. Not only are investors paying to lend governments money, but they retain all the credit and interest rate risk with no compensation. That’s anything but boring.

Where to turn in a world of NIRP?

Logically, investors are seeking more rational alternatives. Dividend stocks have proven alluring against a backdrop of negative yields. US dividend stocks are particularly attractive. Positive real yields and a steadily growing US economy will likely help companies generate the free cash flow necessary to pay out, and eventually grow, dividends. The US private sector has been producing strong, if not record, free cash flow since the end of the global financial crisis. And dividend-paying stocks outside the US have proven attractive in many developed markets as well. The key is not to chase the ones with the highest yields — they can be dangerous — but to look for sustainable cash flow growers.

Absent a recession, which is often fueled by excessive credit growth, investment-grade credit markets look like an attractive alternative to government securities. They are relatively cheap by historic standards and offer the potential to outperform Treasuries in a mildly rising interest rate environment. It is our belief that against the present backdrop moderate additions to risk assets may be appropriate for some investors. Moving out the risk spectrum, cheap high-yield bonds also look compelling in this environment. And large-cap stocks are another area of opportunity, given their moderate valuations.

This economy may not be as exciting as the latest accusations on the campaign trail, but boring can be a good thing. Especially for long-term portfolios.

James Swanson is the chief investment strategist of MFS Investment Management.

RBS Sells ETF Business To Chinese Asset Manager

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RBS vende su negocio de ETFs a una firma china de asset management
Photo: David Leo Veksler. RBS Sells ETF Business To Chinese Asset Manager

Hong Kong based asset manager China Post has acquired the ETF offering of Royal Bank of Scotland, which consists of ten funds with combined assets of €360m.

China Post is the international asset management arm of China Post & Capital Fund Management. As a result of the acquisition, China Post will become the promoter and global distributor of the ETFs, formerly RBS’s ETFs listed in Frankfurt and Zurich.

Morover, the ETF’s will be seeded with additional capital to make them more attractive to institutional investors, they will also be cross-listed in Hong Kong.

The current fund range offers investors access to commodities, emerging market and frontier market equities, China Post aims to expand the offering with a new smart beta strategy offering investors access to Chinese equities.

Danny Dolan, managing director of China Post Global (UK), comments: “This acquisition demonstrates China Post Global’s long term commitment to the European region. Our aim is to differentiate ourselves through innovation. For example, while ETFs giving exposure to China and smart beta strategies already exist, no-one in Europe has yet combined the two.”

“Other differentiators for us include our access quotas to mainland Chinese securities, the strength of our parent companies and their distribution networks, and the strong financial engineering background of our team, which will help with product construction” he adds.

 

 

Does the Loan Market Continue to Offer Attractive Opportunities?

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Los préstamos apalancados: ¿por qué pueden ser una atractiva fuente de "income"?
Photo: Steven Oh, Global Head of Credit and Fixed Income at PineBridge Investments. Does the Loan Market Continue to Offer Attractive Opportunities?

The leveraged loan market has more than doubled in the past decade to US$872 billion, with over 1,000 issuers. Steven Oh, Global Head of Credit and Fixed Income at PineBridge Investments, provides his views on the current state of the loan market, and whether this opportunity is attractive and sustainable.

Why are loans an attractive asset class in the current environment?

The outlook for US GDP growth for 2016, while weakening somewhat recently, is still in the 2%-2.5% range, providing a stable backdrop for leveraged-loan issuers.

The unemployment rate should trend even lower and wage growth is expected to accelerate modestly. Coverage ratios (EBITDA-capital expenditures/interest) are near all-time highs. The current default rate of 1.33% is still significantly below its historical average and is forecast to increase at a gradual rate.

What are the characteristics provided by loans that appeal to investors?

Leveraged loans can perform well in all market cycles. Loans rank at the top of the capital structure, so recoveries are generally higher than for high yield bonds. They provide a hedge against rising interest rates since spreads are typically based off of three month LIBOR.

Leveraged loans provide a high level of current income, with the loans market offering transparency and some liquidity.

Furthermore, leveraged loans are a stable asset class: There have been only two years of negative returns since 1997.

Do you believe that the opportunity to invest in loans will be sustainable? If so, why?

The leveraged loan market has more than doubled in the past decade to US$872 billion, with over 1,000 issuers. It is now a mature market that offers several benefits to issuers and investors alike.

What will be the impact of stricter rules and regulations on the banking sector?

While most loan issuers have multiple market makers, stricter regulations have adversely impacted liquidity. In general, commercial and investment banks that trade loans now hold less inventory. Additionally, regulators are scrutinizing leverage loans much more thoroughly than prior to the financial crisis. This is having the effect of keeping leveraged levels at more moderate levels. The amount of leveraged buyouts with debt multiples of seven times or higher is currently less than 4% as compared with 30% in 2007.

How do you think this market differs across Europe and the US?

The European loan market had been holding up better than the US market in 2015. Spreads are generally tighter despite intrinsic European challenges of lower liquidity and diverse jurisdictions.

But Europe has also weakened in 2016 due to reduced demand from one of the largest participants in the European loan market: CLO’s. At current levels, we believe investors are adequately compensated for expected defaults, although we could see further volatility.

Will that affect your portfolio positioning?

Given that the US market is considerably larger, the vast majority of our holdings are US domiciled; however, we are constantly evaluating relative value between the US and European markets. In our Global Secured Credit Fund, we shift allocations between the US and Europe based on our determination of relative value.

How do you analyze companies?

We conduct a detailed bottom-up credit analysis combined with top-down economic views. It is highly credit intensive and involves a globally coordinated team approach.

What are you typically looking for when deciding whether to invest?

We seek companies with sustainable business models, and consistent, positive cash flows. We also focus on fixed charge coverage, liquidity, and operating cash flow to ensure the amount of leverage is appropriate given the industry sector. Companies in cyclical industries should have less leverage and more liquidity to ride out commodity cycles.

How much more significant will company analysis be in this asset class compared with traditional assets?

In our view, fundamental credit analysis is the key to success in the leveraged loan asset class. Issuers are generally rated BB or B, and therefore have higher levels of risk compared with investment-grade issuers.

What risks are associated with loans, and how can you ensure you are compensated sufficiently for them?

The primary risk associated with leveraged loans is default risk. The key to avoiding credit loss is extensive analysis and monitoring of credits. We evaluate current spread levels to ensure we are being compensated for the expected level of default risk.

In the current environment, we believe spread levels are very attractive given our default expectations.

Are you being compensated enough for the associated illiquidity risk?

Although there has been a slight reduction in liquidity levels due to increased regulation, liquidity in the leveraged loan market is much less of a concern today than a decade ago.

Given current spreads, we believe investors are being well compensated for both illiquidity risk and default risk.

This information is for educational purposes only and is not intended to serve as investment advice. This is not an offer to sell or solicitation of an offer to purchase any investment product or security. Any opinions provided should not be relied upon for investment decisions. Any opinions, projections, forecasts and forward-looking statements are speculative in nature; valid only as of the date hereof and are subject to change. PineBridge Investments is not soliciting or recommending any action based on this information.

 

Two Afores Manage 2.2 Billion USD Through Mandates

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Dos Afores acumulan 2.200 millones de dólares en mandatos
CC-BY-SA-2.0, FlickrPhoto: Juan Barahona. Two Afores Manage 2.2 Billion USD Through Mandates

Afores closed March with 152.6 billion in assets under management (AUM). According to CONSAR, 13.8% of that is invested in international equities and 1.4% (2.2 billion) are under investment mandates. Only two of the eleven Afores in Mexico (Afore Banamex and Afore XXI Banorte) use mandates so far. Approximately 60% of allocations were made by Afore Banamex and 40% by Afore XXI Banorte.

An investment mandate through third parties is an investment vehicle of recognized value used by pension funds around the world, both in developed countries and emerging economies. In LatAm, central banks and Afores use mandates as the AFP use mostly mutual funds and ETFs.

Through this vehicle (where the Afore hires the services of a Global Asset Manager), Afores can effectively invest in international markets through specialized and experienced investment teams around the globe.

In all cases, the Global Asset Manager invited must meet requirements approved by the Committee for Risk Analysis (CAR) of CONSAR concerning experience, operational capacity, corporate governance, transparency, integrity and competitiveness criteria, among others.

Investment mandates in eligible countries are part of international diversification that Afores can perform. The set of eligible countries include members of the European Union, members of the OECD with which Mexico has a bilateral free trade agreement, members of the Pacific Alliance whose capital markets are integrated in the market known as conforms MILA and the member countries of the Financial Stability Committee of the Bank for International Settlements.

CONSAR authorized mandates in 2011, Afore Banamex began funding theirs in 2013 and Afore XXI Banorte stated funding them this year. It is expected that a couple of Afores join them this year and, that Asian equities also join the mix.

According to the CONSAR, Afores currently invest in 17 countries,  but 40% of the international AUM is invested in the United States; while 26% in global indices; 15% in Japan; 5% in China; 4% in Germany and 3% in the UK. With investments between 1 and 2% are Hong Kong, South Korea, Italy and Canada; and with less than 0.5% are Switzerland, Spain, France, Brazil, Sweden, Australia, the Netherlands and Finland.

So far were two areas in which mandates have been assigned: European Equity (82%) and Global Equities (18%). Participants of mandates in European equities are: BlackRock, Pioneer, Schroders, BNP Paribas and Franklin Templeton; while the Asset Managers with mandates in global equities are BlackRock and Schroders.

To date, only 7% of the potential assets allocated to mandates are used given that Afores can mandate up to 20% of their AUM, which is equivalent to 30.5 billion, but considering that there is also a limit on investing in international assets this number is adjusted to 21.8 billion USD still to be mandated.