Shareholder Engagement in Japan – the Impact of Covid-19

In the fifteen years since the inception of the Japan Stewardship strategy, there have been landmark changes in the political, legal and regulatory environments in which shareholders engage with the management of the companies in which they invest. The introduction of the Stewardship and Corporate Governance codes under the aegis of Abenomics has been accompanied by a greatly increased management receptiveness to shareholder engagement and the potential scope of such engagement has also widened.

On the shareholders’ side, Environmental, Social and Governance considerations have become integrated into investment processes worldwide and the legitimacy of investors’ influencing management in these areas has been widely recognised.

For reasons we have often explained elsewhere, the nature of Japan’s society and typical corporate culture has meant that, within our ESG framework, the “G” factor has hitherto been most relevant to our stewardship engagements. That said, while the psychological scars resulting from the Fukushima earthquake and tsunami remain quite livid, this new crisis has reinforced the understanding of the Japanese people, and of administrators and corporate managers in particular, that ESG considerations are essential not only for some abstract notion of sustainability, but for the very survival of companies and of the society in which they operate.

The team at Nissay Asset Management charged with in-depth engagement with management has, over the years, addressed a range of operational, financial and governance issues and has always done so in a constructive manner, based on close and generally cordial relationships with managers. This style has not changed with the advent of Covid-19, but the focus of the engagement has naturally shifted with some companies, as management adjust to the shock and realities of the pandemic’s impact.

Our strategy has always focused on quality companies which have clear competitive strengths and growth potential, but which also exhibit some weaknesses whose amelioration or elimination would add significantly to shareholder value. Perhaps the most common weaknesses have been seen in balance sheet management, typically in the accumulation of excessive cash reserves, to the detriment of ROE. This has most commonly been addressed through share repurchases, dividend increases and/or the stipulation of clear ROE targets in corporate planning.

Some (typically, older generation) senior managers have resisted pressure to reduce excessive cash piles, sometimes citing the “rainy day” defence or claiming that cash is being accumulated for future acquisitions. Whilst these claims are often simply smokescreens to conceal a rather simplistic tendency to regard cash reserves as a yardstick of management success, the advent of some (very) rainy days with Covid-19 has brought some ostensible justification to the former stance and may result in some testing of the latter.

To be clear, we do not believe that Covid-19 has derailed the progress made in this area, or that engagement on the issue has become less relevant or feasible. While the lessons of the pandemic might justify some raising of the bar of acceptability in balance sheet inflation, our engagement on such issues, which has always been nuanced anyway, will continue with the principal criterion being the implications for ROE. In this, we believe that deep knowledge of company fundamentals, a thorough understanding of sector dynamics and close relationships with management will be more important than ever in the months ahead.

Meanwhile, the fact that many weaker companies now find themselves in straitened circumstances may create “survivorship bias” and opportunities for acquisitions by the stronger operators in their respective sectors. Our portfolio companies are usually leaders in their fields, and we may see increased M&A activity within the portfolio as a result.

The widespread discussions of a post-Covid-19 “new normal” imply a willingness to embrace changes in life and work which might previously have been considered radical, while some of our portfolio companies stand to benefit from the acceleration of existing trends – as suppliers of relevant goods and services, notably Infomart, Justsystems, MonotaRO, M3 Inc. , GMO Payment Gateway and, potentially, Nihon M&A Center.

Over the coming weeks, we intend to utilise the close relationships we have with corporate managers across a wide range of sectors to ascertain how management thinking is changing in response to this unprecedented challenge. Our a priori expectation is that, as suggested above, many will be increasingly concerned with corporate sustainability and all that this entails.

It is also likely that the inefficiency of many traditional practices (the problems associated with hanko (signatory seals) have, for example, been highlighted in the media) will be understood and the move to more general digitalisation, an area in which Japanese companies are often lamentably backward, will be accelerated. This post-Covid-19 consciousness should strengthen our hand in engagements with managers on issues which we are commonly addressing – including inefficiencies in cash flow management, factory operations, procurement, and supply chain and customer relations management.

In the aftermath of Covid-19, the continued threat of a resurgence of the disease will continue to have a marked effect on the operations of companies and their relationships with one another, with customers, employees and government in the medium term, and, if and when the pandemic is finally relegated to history, some of these changes are likely to be sustained.

The management landscape will have changed, and, in all, we expect to see increased possibilities in pursuing our ESG and stewardship agendas. If anything, the coronavirus crisis has given new force to our arguments and highlighted the need for companies to strengthen themselves and to build better, more sustainable, and ultimately more valuable, businesses.

The names shown above are for illustrative purposes only and is not intended to be, and should not be interpreted as, recommendations or advice. No investment strategy or risk management technique can guarantee returns or eliminate risks in any market environment.

Unless otherwise stated, all opinions within this document are those of the RWC Japan Active Engagement Team, as at 10th June 2020.

The term “RWC” may include any one or more RWC branded entities including RWC Partners Limited and RWC Asset Management LLP, each of which is authorised and regulated by the UK Financial Conduct Authority and, in the case of RWC Asset Management LLP, the US Securities and Exchange Commission; RWC Asset Advisors (US) LLC, which is registered with the US Securities and Exchange Commission; and RWC Singapore (Pte) Limited, which is licensed as a Licensed Fund Management Company by the Monetary Authority of Singapore.

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RWC uses information from third party vendors, such as statistical and other  data, that it believes  to  be reliable.  However, the accuracy of this data, which may be used to calculate results or otherwise compile data that finds its way over time into RWC research data stored on its systems, is not guaranteed. If such information is not accurate, some of the conclusions reached or statements made may be adversely affected. RWC bears no responsibility for your investment research and/or investment decisions and you should consult your own lawyer, accountant, tax adviser or other professional adviser before entering into any Transaction. Any opinion expressed herein, which may be subjective in nature, may not be shared by all directors, officers, employees,  or representatives  of RWC and may be subject  to change without  notice. RWC is not liable  for any decisions made or actions or inactions taken by you or others based on the contents of this document and neither  RWC nor any of its directors, officers, employees, or representatives (including affiliates) accepts any liability whatsoever for any errors and/or omissions or for any direct, indirect, special, incidental, or consequential loss, damages, or expenses of any kind howsoever arising from the use of, or reliance on, any information contained herein.

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The Alternative  Fund Managers Directive (Directive 2011/61/EU) (“AIFMD”) is a regulatory regime which came into full effect  in the EEA on 22 July 2014. RWC Asset Management LLP is an Alternative Investment Fund Manager (an “AIFM”) to certain funds managed by it (each an “AIF”). The AIFM is required to make available to investors certain prescribed information prior  to their investment in an AIF. The majority of the prescribed information  is contained in the latest Offering Document of the  AIF. The remainder of the prescribed information is contained in the relevant AIF’s annual report and accounts. All of the information is provided in accordance with the AIFMD.

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