Thursday, December 22, 2011

Asia Note: Japan Trip Report (send to email list on 20 Dec 2011)

In Tokyo and Fujisawa last week, I had two days of meetings followed by three days of eating and drinking too much.  As some of you know, I like good sake and I was not disappointed as I discovered some gems.  But that is the subject of a meal, not an email.

December in Tokyo is a chance to catch-up with old friends, enjoy the Christmas lights, and eat and drink.  Christmas is more of a couples event with the key family holiday celebrated on 1 January (which is more like their Christmas or Chinese New Year).  

I returned to HK positive about the country and its investment merit.  A lot of this has to do with valuations.  Large cap index Japan remains the least expensive market on a P/B basis amongst developed markets as well as compared to all Asian markets (but not on a PE or yield basis). 

Many companies have no coverage at all as Japanese and foreigners seem to have virtually given up.  There are many companies trading below replacement cost, Graham net-nets are numerous (over 400 according to one manager I met), etc.  In short, it is good hunting ground value investors. 

I met with a handful of managers and others in the financial community.  And sure enough, the value guys have done well.  And this may continue as stocks are still cheap.

Thoughts are below.


My expectations were not high. I had been told by Japanese friends living in HK that they would never move back to Japan due to fears of radiation and/or not trusting the Japanese government.  They also noted that many rich Japanese have left Japan for good.   My mid-day, mid-week HK/Narita and return flights were likely about 50% full.  Not sure if this was due to it being the slow season or people staying away from Japan due to radiation fears.  I suspect it is a little of both.  

The picture I got from in Tokyo was very different.  I had not been there for over 1.5 years so my last trip was before the earthquake, tsunami, and nuclear plant trifecta.  In its wake most my contacts in the financial industry sent their families to southern Japan while they worked in Tokyo. While many say there are not as many gaijin in Tokyo as before, all my Japanese contacts are by-and-large back to their regular working and home routine.  

My contacts did not think it was a watershed event that will change Japan as some English press and commentators had described. I was told that people are more apt to live for today rather than save for the future. But savings rates have been coming down in Japan for a while. People are concerned and still think twice about eating or drinking certain things. Almost everybody in Tokyo is drinking bottled water, and a popular children's milk powder supplement recalled its products after higher than normal radiation was detected (albeit within acceptable limits).  

My Tokyo financial community contacts are also relaxed about the recent Olympus scandal.  Like Buffet, several compared it to Enron and believe it is an isolated incident rather than an example of the ever presence influence of Yakuza in corporate Japan, or of many companies rife with poor corporate governance and controls.

Buffet's Japan trip - which I thought should be a catalyst - was also brushed off as a non-event.  But than he's invested in many US companies in the last nine months and publicly said this is a good time to invest, yet cash levels remain high and equity holdings low.

While everybody I met said that equities are cheap, nobody could think of a catalyst.  But this tends to be a Catch-22 situation as once a clear catalyst emerges, prices have likely already reacted or will soon. 

One potential catalyst (in my opinion) could be good past performance that may spur others to jump on board.  Most people and managers are momentum players after all.

One of my favorite L/S funds is up over 25% in the last two years in Yen terms. Add in about 15% increase in the Yen and we get about 40% returns to USD investors. One manager's small cap fund was up even more. A very active L/S fund is up 55% since July 2010, and over 25% YTD (in USD terms).   Fund NAVs of my small sample set are substantially above their pre-Lehman high. 

Despite the good performance, valuations are not demanding. The funds’ underlying investments average 8-9x PE, 0.9-1.3x PB, and 2-3.5% yield.  The active L/S fund has a net exposure of over 110% - one of its highest ever - and no short positions as manager thinks valuations are too low to short.

And I agree with him.  Japan remains Asia’s (and possibly the world’s) cheapest market on a PB basis, dividend yield is twice JGBs’, and it is not hard to find stocks trading at 4-5% yield, below 1X PB, and less than 6x PE.

This all reminds me of the famous Graham quote about the market being a weighing and voting machine depending on the time horizon.  It also reminds me of an Economist article from 2007 and manager visits since then which all noted the significant changes that are taking place in Japan.  The article noted that the changes are very real, but said they will play out in "typical" Japanese fashion – slowly and quietly.  Thus they will not be wrapped in a PR campaign as corporate restructuring are in the US or Europe, but instead happen over a longer period of time with little fanfare. If true this makes for a good case for employing a knowledgeable manager.

Some changes / notes:  

- Increase in entrepreneurialism.  Had coffee with a friend's contact that has retired from JAL and is advising a start-up mid-range LCC (budget airline).  Others I met socially had started their own companies: real estate entrepreneurs, bento box assembly and delivery, insurance product distribution, and others who are thinking of branching out on their own.

- Necessity is the mother of invention. Another person I met has a part-time job in addition to his full-time job. This used to be verboten in Japan, however I was told this is nothing special and many companies are encouraging their employees to take additional jobs and work.  His firm cut its employees' pay and asked them to take outside jobs, allowing them to leave at 4 or 5pm to do so. 

- Women working.  I had a fun sushi night with several 30-something successful women working in a variety of fields - online marketing, logistics, executive assistant, etc.  Other workingwomen contacts include a deal negotiator for a large Japanese chemical company and a woman who recently sold her venture-backed headhunting company.

- Home is not sacrosanct - I was told that several months ago, Nomura laid-off Japan-based employees for the first time ever.  In the past it had only let go non-Japan based staff. Foreign financial firms continue to downsize.

- Increase in risk?  On the marketing front, I had a better reception than before.  Distribution channels besides the large trust and investment banks are opening-up.  There are signs that pension funds are starting to (finally) hire full-time finance professionals instead of long-serving, loyal former employees.

- Value – Even with the Yen increasing since I was last there, I did not feel things were too expensive.  I’m coming from HK – which is not cheap - but it seems that property prices and prices of clothes and toiletries were not too expensive – especially outside Tokyo. And given the Japanese emphasis on quality they seem to represent good value.


In short, I returned more positive on Japan than when I left.  It has the right characteristics for active managers to continue to do well – lot’s of cheap stocks, world-class efficient recession-tested companies, educated workforce, rising per-capita income, increasingly open to change, few people in the playground, etc. Not sure what the indexes will do, but with over 2,000 listed companies I suspect there’s a lot underpriced gems there.

The first attached picture is likely the world’s most advanced vending machine.  It was taken on one of Tokyo’s train platforms, and is a 30- or 40-inch flat touch screen that switches between showing commercials and a simulated physical vending machine face.  The second is from a Fujisawa personal care store that shows bags of refills next to their standard packaging. 

Best Regards,


Tuesday, November 29, 2011

CAIA - Smart Moves Submission

Smart Moves – Dec 2011

Michael McGaughy, CAIA, has had his new book published.  Called Inside China’s Corporations, it maps and explains the corporate structure and control of China and Hong Kong’s conglomerates - both family and government-owned.  It highlights their key people, structure, and business lines at both the parent and listco levels.   The role of China’s communist party in corporate control is explained through both bottom-up and top-down charts and examples. All HK, Shanghai and Shenzhen listed entities over US$2bn in market capitalization are mapped to their parent group. (Sample pages can be seen at ( It can be purchased direct form the publisher Amazon, or IND-X Securities where it can be paid for through brokerage commissions. 

The book follows several other similar reports he has written on ASEAN, Indonesian and Malaysian conglomerates and prominent business families.

Said Michael, “The CAIA program rounded out my fundamental buy- and sell-side analysis and manager selection background.  Having been based in Asia for most of my career it was particularly useful to understand new products and investment styles that are new to the region and many times not here yet.  The designation and networking opportunities at local chapter events has expanded my network and has altered my way of looking at investments and investing. “

Michael McGaughy, CAIA, consults to asset allocators, funds and research organizations on manager and product selection, marketing and fundamental equity, ETF and index analysis, through his company Kairo, Ltd.  An award winning analyst, Michael has a diverse financial background spanning buy- and sell-side equity research, private-equity fund management, fund- of-hedge funds management, business development and investor relations. He first came to Asia as an exchange student in 1985 and has been involved with the region ever since, having lived and worked in Beijing, Hong Kong, and Singapore, for different companies including HSBC, the old Crosby Group and StoneWater Capital.  He earned a bachelor’s degree in economics from the University of Vermont.  He has been a CAIA member since November 2010 and currently sits on the Hong Kong chapter’s executive committee. 

Monday, November 28, 2011

History Helps

” We must study the present in light of the past for the purposes of the future.”  John Maynard Keynes

One thing that cannot be replaced is a company’s history and background. While one cannot invest in the past, one can learn from it, however very few in the increasingly short-term oriented financial industry have the time to really get to know the background and in and outs of the companies they invest in, and the shareholders that control them.  In “Build to Last” a book by Jim Collins and Jerry Porras, the two authors note that a key trait of long-term successful companies is its history and the values and culture embodied in its history.  Essentially getting off on the right foot, can have huge implications for a business in the long-term.  In the west Coca-cola (125 years old in 2011) is an example.  (FT, Morgen Witzel, 15 July, History Classes that Offer Management lessons for the present and future). This is particularly true of the major or majority shareholders that typically control the larger listed companies in Asia, ASEAN included.   We will illustrate the importance of this through an example.

In 1991 when I wrote my first report on Asian business groups for the old Crosby Group (insert title here) I did it for two reasons.  One was because the same names kept appearing on prospectuses, annual reports, and financial publications.  Secondly, at the time there was little to no organized information on Indonesian companies as, if memory serves me correctly, there was little to no information on Bloomberg and other data providers and no consensus forecasts that may have served as an anchor for the analysis.  My anchor instead was to focus on who owned, and controlled what, and what are the ramifications for minority investors.  I had to write a lot of this down as Indonesian names and spellings were new to me, the Indonesian Chinese had different names including their Indonesian name, and different translations of their Chinese names depending on which dialect they used.  In short it was very confusing, so I had to write it all down and try to connect the dots. 

One key thing I remember was that I thought Sinar Mas’ controlling family the Widjaja’s, were not up to snuff.  Eka had tons of wifes, was taking money away from shareholders in a small chemical company (UIC) to his private companies.  Further, I kept hearing rumours amoungst the Jakarta based business community that the ethnic Chinese businessmen from Medan were not to be trusted (Eka’s family is from there), and that the Sinar Mas group was rumored to not be on the up-and-up.   The sort of Indonesian Chinese family that has little regard for Indonesia , its environment, etc.  They were also involved in the paper business, which survived on Indonesia’s vast forest reserves, and there were ample rumors that Sinar Mas had little regard for the environment.  Despite being a the time the largest business group in Indonesian after the Salims, the key take away from the first report was that the Widjajas are not someone I would trust and that I would not want my fund manager to take anything more than a day trade in their listed companies’ stock.

By 1992 I was no longer covering Indonesian stocks, but instead starting to write research and develop the Crosby Groups business in the Indian subcontinent, later moved into Mainland China private equity; and lost sight of what the Wijaya’s and their Sinar Mas group were up to.

Fast forward to 1998 and headlines about APP, the largest corporate default up to date, and who was behind it – the Wijaja’s.  When I learned of the amount of bond and loan defaults I was truly amazed.  The bankers and investors must have heard the same rumours I had, and either chose to ignore them, or perhaps were forced to loan money to SE Asia as that was the darling of the financial community before 1997.  But perhaps the new-kids-on-the-block bankers did not do their homework on Sinar Mas and the Wijajas, which I suspect is true.  There is no shortage of fresh blood in today’s capital markets.  Youngish analysts keen to make a name for themselves, just out of “B-school” bankers itching to use their family and alumni network to strike a deal, and no shortage of trainee fund managers who do not know or have the time to spend looking into the background of the majority shareholders as their Asian posting may be a 2-3 year stock on the career ladder. 

Negative Local Press

Last week's HK local press had a lot of negative headlines.

This is in-line with several smaller and value oriented fund managers I know who invest in small and mid-cap Asian stocks. As expected several of them are seeing more buying opportunities, and/or running high net exposures (i.e. buy when others are fearful, sell when others are greedy).
Below are some SCMP ( headlines found in last Monday's edition:

  • "Warning on Risk of Property Bubble - Hong Kong's Finance Chief says the price of flats has not fallen to a satisfactory level - but he does not say what they should be, or if there will be more cooling measures"
  • "Currencies - Fears Capital is Fleeing Mainland - Foreign exchange purchases enter negative territory for the first time in four years"
  • "Global economic conditions remain grim, and ensuring economic recovery is the priority", China Vice-Premier Wang Qishan 
  • Asia - "Regional Tale of Gloom and Doom - Economic data tells a story of weak growth, and expectations are that things will only get worse (See below) 
  • "Like a Ton of Bricks - Hong Kong Property Prices Could Be Poised For A Large Fall In Value" - (28 Nov 2011 SCMP

Regional tale of gloom and doom

Economic data tells a story of weak growth, and expectations are that things will only get worse

Agencies in Tokyo, Seoul, Bangkok and Singapore
Nov 22, 2011
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Economic data from Japan, South Korea, Thailand and Singapore point to a global economy that may be weakening more sharply than expected.
"Things are going to get worse before they get better," said Vishnu Varathan, a Mizuho Corporate Bank economist in Singapore. "Export growth will slow across Asia and we may see financial shocks coming through. Asian policymakers are going to become stimulatory all over again."

A record of the Bank of Japan's October 27 meeting released yesterday showed that one board member favoured adding 10 trillion yen (HK$1.01 trilllion) in asset purchases, and Chinese Vice-Premier Wang Qishan said his nation must adopt a more "forward looking" and flexible monetary policy.
Separate data showed that Japan's exports fell at the fastest pace in five months in the year to October as a strong yen and sputtering global growth weighed on the recuperating economy.
Although Japan's economy expanded 1.5 per cent in the previous quarter, rebounding from recession triggered by the March earthquake and nuclear crisis, it is expected to slow sharply in October-December. Severe floods in Thailand, a major manufacturing base for many Japanese exporters, are expected to add to global headwinds faced by the world's third-biggest economy.
Japan's exports fell 3.7 per cent last month from a year earlier, far more than a 0.3 per cent dip forecast, and follows the central bank's warning that government debt woes in Europe were already hurting Japan and emerging economies.
The October fall was the biggest drop since a 10.3 per cent fall in May, with shipments of semiconductors and other electronic goods falling due to strength in the yen.
South Korean customs agency data showed yesterday that exports grew just 2 per cent in the first 20 days of this month from a year ago, while imports rose 3 per cent.
In Bangkok, the government yesterday said it had cut its forecast for economic growth this year to 1.5 per cent because of the floods.
The flooding in Thailand has also disrupted supply chains of Japanese car and electronics companies. Toyota, Asia's largest carmaker, reported that its profit fell 19 per cent in the third quarter.
Singapore yesterday lowered its forecast for non-oil domestic exports, estimating overseas shipments to rise 2 per cent to 3 per cent this year, lower than a forecast of 6 per cent to 7 per cent.
The government also said the economy could contract in the fourth quarter and growth next year was likely to slow due to the weakness in the Western economies.
"This [2012] forecast is based on current known external weaknesses. Should a recession or a full-blown financial crisis in the advanced economies occur, growth could come in lower," said Ow Foong Pheng, permanent secretary at Singapore's Ministry of Trade and Industry.
Reuters, Bloomberg