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Hisashi Arakawa, Investment Manager, abrdn Japan Investment Trust PLC

-Japanese shares sold off as Russia escalated tensions with Ukraine.

-Companies are passing on rising input cost to their end customers.

-Recent earnings reports for the Japanese corporate sector have been buoyant.

Japan has not been able to escape the global stock market volatility seen in the wake of the Russia/Ukraine crisis. However, with less geopolitical involvement and a robust corporate sector, it may prove a port in the storm for investors.

Japanese shares sold off as Russia escalated tensions with Ukraine. However, the country’s stock market has outperformed the global average, with value stocks and smaller companies showing the strongest performance. The preference for value stocks is perhaps understandable given the shifting interest rate environment and inflationary pressures. However, this has left many high-quality stocks looking good value at a time when, we believe, quality traits such as pricing power and resilient balance sheets will be particularly important.

Inflation is an issue in Japan as the impact from the sharp rise in commodity prices puts pressure on companies’ profitability. However, price rises are relatively low compared to other developed markets across the globe. The Tokyo core consumer price index (CPI), which excludes fresh food but includes energy, rose 0.8% year-on-year in March. This is marginally higher than forecast and is likely to move higher as energy prices rise, but doesn’t come close to the 6-7% rises seen in the UK and US. At the same time, recent newsflow suggests that price increases are increasingly widespread: Starbucks Japan, for instance, raised its standard beverage prices by 22% and its coffee bean prices by 40% in mid-April; this is the first time since 2006 that the company has raised its coffee bean prices. With the continual rise in input prices, investing in companies with pricing power will be important – and a number of our invested holdings are intent on maintaining their profitability.

Meanwhile, Japan’s economy is finally reopening, albeit gradually, after continual waves of Covid-19 infections and concerns of the burden on its healthcare system. In its latest World Economic Outlook, the International Monetary Fund (IMF) predicts growth of 3.3% for Japan over the year, though fourth quarter GDP growth came in at a punchy 4.6%. Japan’s quasi state of emergency was lifted in 18 prefectures, including Tokyo and Osaka, towards the end of March. The country also relaxed its border controls further from March, and the booster shot campaign that began last December had reached 41% of the population as at the end of March.

Corporate sector bouyant

However, as always, it is not the economy that is interesting in Japan. It helps to have a supportive backdrop, but Japanese companies are well-versed in operating in difficult climates. Recent earnings reports for the Japanese corporate sector have been buoyant, with lots of companies reporting profit increases, and a large number announcing share buyback programmes. Dividends have been another area of strength.

At the same time, global investors have still not re-embraced Japanese markets. While there are signs that global asset allocators are turning their attention to the country again, valuations are still attractive for Japan after a long period out of favour. This is particularly true where companies possess resilient business models, strong balance sheets and structural improvements in governance, the natural hunting ground for abrdn Japan Investment Trust.

Global trends

As we see it, Japanese companies are embedded in some of the most exciting global trends. For example, it is possible to find world-leading companies in the all-important semiconductor supply chain. Japanese prominence in robotics is likely to be rewarded as factory automation becomes an increasing priority to counter wage inflation.

Japanese car makers have been early and successful proponents of electric vehicles (EVs). Toyota Motor, for example, has recently committed to release 30 different EV models by 2030, up from 15. It hopes to sell 3.5 million battery EVs globally by 2030 and to transform Lexus into an EV-only brand by 2035.

Prime Minister Kishida is a bold supporter of these trends. His ‘new capitalism’ proposal is based on four key pillars: innovation – promoting Japan as a science and technology nation; Digital Garden City Nation vision – the advancement of Japan’s digital capabilities; tackling climate change – through a focus on clean energy and gradual decarbonisation; and economic security – enhanced support for research and development in cutting edge technology.

In our portfolio, we were already invested in Toyota, but more recently we have positions in Ibiden and Kohoku Kogyo. Ibiden is a manufacturer of packaging substrates that protect semiconductors. We expect a rapidly growing end-market and are encouraged by the improved business mix achieved over recent years, with reduced reliance on cyclical applications such as smartphones.

Kohoku Kogyo is the global leader in manufacturing of key components used in submarine optical cables and automotive aluminium electrolytic capacitors. The company’s integrated production system and its ability to produce everything internally from raw materials to equipment enables the company to maintain its moat. The president, who comes from the founder’s family, is keen to establish a third pillar of growth, leveraging the company’s existing technologies.

Companies with strong business models and management teams have coped and even thrived in the last two years, even if that hasn’t always been reflected in share prices. Alongside structural improvements in governance in Japan, we remain resolute in our belief that these companies should do well whatever the broader economic conditions. Companies with a good potential runway of growth and competitive strength should be at a notable advantage today.

Companies selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.

 Important information

Risk factors you should consider prior to investing:

-The value of investments, and the income from them, can go down as well as up and investors may get back less than the amount invested.

-Past performance is not a guide to future results.

-Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.

-The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.

-The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.

-The Company may charge expenses to capital which may erode the capital value of the investment.

-Derivatives may be used, subject to restrictions set out for the Company, in order to manage risk and generate income. The market in derivatives can be volatile and there is a higher than average risk of loss.

-Movements in exchange rates will impact on both the level of income received and the capital value of your investment.

-There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.

-As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.

-Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.

Other important information:

Issued by Aberdeen Asset Managers Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Registered Office: 10 Queen’s Terrace, Aberdeen AB10 1XL. Registered in Scotland No. 108419. An investment trust should be considered only as part of a balanced portfolio. Under no circumstances should this information be considered as an offer or solicitation to deal in investments.

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Issue Date: 17 May 2022