Please see the below update posted last week by 2 of Jupiter’s Japanese Equity fund managers.
Dan Carter and Mitesh Patel discuss the increasing frictions between China and other developed nations, as Japan seeks to limit foreign influence on companies and the US rhetoric toughens. What are the implications for globalisation and supply chains, which are already showing fragility as a result of Covid-19?
In October last year we focused upon Japan’s Foreign Exchange and Free Trade Act (FEFTA), after planned revisions to this seemingly arcane piece of regulation sparked fears of a chilling of the increasingly febrile activist scene, setting back Japan’s progress to better management and a better functioning market. In late April 2020, however, the Japanese Ministry of Finance (MoF) clarified the revision to the Act and explained that almost all investors would be excluded from the most restrictive requirements such as seeking pre-authorisation for stock buying.
In its announcement, the MoF considerably assuaged concerns that the revision was a conspiracy to restrain meddlesome foreign activists, but in doing so confirmed the official narrative: that this legislation is designed to regulate state-directed investment into Japanese companies operating in strategic sectors. Whilst many investors are wiping their brows that the conspiracy theories have been (almost) put to bed, it seems to us that the implication of the official narrative is likely to be a power greater to investors in the mid to longer term.
An uncomfortable reality
The revised FEFTA flashes the spotlight on an uncomfortable reality. As it grows in size and influence, China’s aim of being global number one becomes ever more concerning for the US and its allies such as Japan. The friction caused as these national strategic ambitions grind against one another has already begun to affect the investment landscape – through curbs on FDI such as FEFTA – and will continue to do so into the longer term. But how?
One theme could be the de-globalisation of manufacturing, also known as re-shoring. In its Covid-19 recovery package the Japanese government announced that ¥244bn (c.$2.2bn) would be earmarked for companies wishing to bring production back to Japan from China. The pandemic has highlighted the fragility of global supply chains but also provided cover for a shot to be fired in this new cold war. We have previously written about the trade interdependence between China and Japan.
If cross border supply chains do begin to become untangled then clearly Japan will need to make more of its own machinery, textiles and chemicals. As investors we have sought to avoid manufacturers of basic materials and that will not change, but there may be producers of more value-added intermediate products which warrant attention. If reshoring does gather pace, Japan’s continually dwindling labour force suggests that factory automation companies, engines of efficiency such as Daifuku (which is held in the strategy), will be relied upon increasingly heavily. It is not all good news though; a repatriation of Japanese production would also mean a concentration of currency exposure once again. For too long Japanese manufacturers’ profits were tied closely (inversely) to the yen, globalisation at least allowed these bindings to be loosened and a reversal would be unwelcome.
Technology as a battleground
Perhaps the primary battleground is likely to be technology. The Huawei affair has highlighted the extent to which Chinese technology has become relied upon internationally. Similarly, China continues to need overseas companies, such as the semiconductor production equipment makers, to facilitate the build-out of its own strategically important tech industries. If Chinese ambitions continue to jar with those of the US, as well as Japan and Europe, the result could be increased technological self-sufficiency. As investors we need to carefully weigh up the opportunities and threats of this eventuality – a technological arms race will only make the possession of real technology leadership, enjoyed by companies like Lasertec and Tokyo Electron, more valuable, but a deeper fissure between geopolitical blocs could restrict addressable markets.
As investors we are hypervigilant of the temptation to overreach – we are not setting up any heroic anti-consensus positions with the above geo-strategic pondering. Rather the competing ambitions of the world’s major players create a reality in which our investee companies must operate – just as economic, social and environmental realities do – and it would be remiss of us ignore this. For so long the world order has been set, roles assumed, and relationships taken for granted. As this order shifts it will be important for investors, ourselves included, to factor these new realities into our decision making.
Jupiter is a well-established fund manager with an increasing presence in Europe and Asia. The views from fund managers provide a good insight into the current market issues.
Andrew Lloyd
15/06/2020