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Japan in crisis: investing in an aging population

By Patrick Collinson
THE GUARDIAN, LONDON
Sunday, Apr 06, 2008, Page 12

"Japan is in a demographic hole. Every year there are more people retiring than are entering the workforce. " — Chris Taylor, head of Neptune Japan Opportunities

Which funds are the biggest losers from the credit crunch?

Shares in banks? Commercial property? No, it’s practically anything invested in Japan.

At the end of 2005, Melchior Japan Opportunities was celebrating a 94.1 percent gain, putting it at the top of the table for all unit trusts over the year. Today it is rock bottom with a fall of 43.6 percent over the past year. Japanese funds from Legg Mason, Axa Framlington, M&G and Schroder are all languishing among the bottom 10 unit trusts. The 2005 bounce in the Nikkei 225 share average was shortlived and confidence levels are at their lowest in a decade.

One of the two Japanese funds that have been in positive territory over the past year is Neptune Japan Opportunities, run by Chris Taylor. But even he is deeply pessimistic about the outlook.

In one anecdote after another he indicates that Japan is a basket case. And it all comes down to demographics.

“This is a country where there are more funerals than weddings. Japan is in a demographic hole. Every year there are more people retiring than are entering the workforce. The people who are joining the workforce are on lower earnings than those who are retiring and a lot of them are now in temporary or casual employment,” he said.

Back in 2005, the belief was that the decade-long stranglehold of deflation and stagnation was now over. Employment was creeping up, property prices had stopped falling and the Nikkei 225 had broken through 16,200.

But three years on it is trading below 12,000, as the hoped-for “broadening out” of the recovery and the return of the consumer failed to materialize.

“The amount of yen being earned by those in employment is in year-on-year decline. There are fewer people and they are earning less money. Just where is consumer demand going to come from? You do wonder how they are ever going to solve the problem,” Taylor said.

Of course, it is not all doom and gloom. One of his preferred stocks is Nintendo. It has been just about everybody’s favorite stock in Japan since it brought out the top-selling Wii games console and is still struggling to cope with demand from stores worldwide.

“The Wii is the only games product that has won customers outside of the traditional gaming categories. It’s a big hit in nursing homes. When it’s freely available maybe I’ll sell out,” he said. “One of the attractions of Nintendo is that they don’t just make money from selling consoles. They make so much more from selling the games software and unlike the others they write most of it themselves.”

There are other bright spots on the Japanese corporate landscape. Taylor’s favorite stock is Unicharm Petcare. The Japanese may not be having any children, but they do have lots of dogs. And Unicharm has a new wonder product: doggy diapers. They’re big in Japan, and about to launch globally.

But the country has suffered a double whammy: the bursting of the asset price bubble of the 1980s and the hollowing out of the economy by Chinese competition. Yes, there are still world-class manufacturers such as Toyota and Sony. But the “mom and pop” smaller companies that for decades provided the nuts and bolts for the giant companies are crumbling.

“Around two-thirds of the Japanese economy is made up of companies with fewer than 10 workers. But a hollowing out of the economy is going on and big companies are using China as the source of cheap, low-tech components,” Taylor said. “Effectively there are two economies: the global exporting companies which lead their sectors and the smaller companies hooked into a shrinking domestic economy.”

As a fund manager, it means you want to be firmly invested in big-cap stocks. The last corporate results season showed mid-cap profits declining by 12 percent and smaller company profits by 40 percent. At large cap companies, earnings rose, albeit by a miserable 1.3 percent.

Does Japan’s experience in handling an asset price implosion and illiquidity in the banks in the early 1990s provide any lessons in how to handle a credit crunch? Taylor is not so sure. Between 1987 and 2002 he was at Fuji Bank and saw first-hand an inability by senior management to face up to problems.

Corporately, he says, they have a habit of brushing things under the carpet. Even when the banks were quasi-nationalized in the early 1990s, it failed to solve the problem.

“Every time they got some capital, they wrote off some loans ... They don’t seem to have a mentality in which you ‘fess up to mistakes and get on with it,” he said.
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