The past 12 months have posed a myriad of challenges for Japanese businesses. A weak yen and rising global inflationary pressures have conspired to raise input prices for many companies, while supply chain disruption has hampered manufacturing. The reopening of China has created volatility. All in all, it has been an environment where macroeconomic factors have weighed heavily on companies’ profitability.

Inflation has certainly been a factor. While Japan is not experiencing the double-digit inflation seen elsewhere, it is a shock for a country used to deflation. Higher commodity prices and the poor availability of raw materials have squeezed margins. For many companies in Japan, it has not been easy to pass on higher prices to domestic consumers.

Supply chains have been significantly disrupted with component shortages and logistics difficulties. This has impacted some of our holdings in the portfolio that rely on parts such as semiconductors to fulfil demand, including robot-maker Fanuc, IT service group NEX and semiconductor tester maker Advantest.

There has also been disruption around the shift in China’s Covid-19 policy. While in the long-term it should boost economic growth and ease manufacturing bottlenecks, in the short-term it has proved difficult, with Covid cases spreading. For example, within the abrdn Japan Investment Trust portfolio, precision component maker Misumi’s suggested that the operating environment in China deteriorated in December, which had impacted results.

That said, even in this tough environment, there were winners. Higher quality businesses, with international operations, had more flexibility to raise prices than those companies with weaker pricing power, or that were focused on the domestic economy. There were those that benefitted from higher global interest rates, such as some of the banks, or high commodity prices. These same companies may have also benefitted from a weaker yen.

Year ahead

Since the start of 2023, the environment has looked quite different. In December, the Bank of Japan surprised markets by loosening the trading range for Japanese government bonds – an effective interest rate rise. This boosted the yen and changed the operating environment for many companies. A stronger Yen should keep cost rises lower, which means company operating margins should start to improve. Those companies that have seen real weakness this year amid difficult macroeconomic factors should have a stronger pathway to growth.

At the same time, supply chain problems are gradually resolving. In its latest results, Fanuc beat expectations saying improving semiconductor supply had a significant impact. NEC also said easing component shortages would help convert its growing backlog of orders into revenue, while Advantest also said that its supply chain difficulties were easing.

We are also starting to see the impact of China’s reopening. Power tool maker Makita’s said its plants in China have returned to normal operations. We see China’s reopening creating a tailwind for the region as a whole and, in particular, better prospects for companies that operate in China. We believe the return of Chinese tourists should provide a welcome boost to Japan’s tourism sector, for example, which is only just emerging from Covid restrictions.

Corporate governance changes

A lot of the broader trends in Japan still remain in place. Restructuring and improving governance continues to be a theme, for example. We recently initiated a position in Hitachi Group, which has been through a restructuring process and is also plugged into the renewable energy theme. It has the world’s leading technology in reducing power losses during energy transmission, particularly important for renewable energy. It stands to benefit from the adoption of renewable energy sources around the world. It also has an ‘internet of things’ platform, which should capture rising digitalisation demand.

There are still areas of risk. While Japanese companies don’t have high debt – in fact, a key differentiator for Japanese companies is that they often run with net cash on their balance sheets – there are companies that will be hit by higher global interest rates. At abrdn Japan Investment Trust, we are generally steering clear of areas linked to discretionary spending.

We know that many of the companies in our portfolio have been preparing for an economic recovery and are well-positioned to take advantage when it arrives. The changing environment forces active fund managers to stay on their toes, with many of the strategies that worked well in 2022 likely to struggle this year. However, we continue to look through the market noise to find those companies that have the potential to thrive in a variety of conditions.

Companies selected for illustrative purposes only to demonstrate the investment management style described herein, and not as an investment recommendation or indication of 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 abrdn Fund Managers Limited, registered in England and Wales (740118) at 280 Bishopsgate, London EC2M 4AG. abrdn Investments Limited, registered in Scotland (No. 108419), 10 Queen’s Terrace, Aberdeen AB10 1XL. Both companies are authorised and regulated by the Financial Conduct Authority in the UK.

Find out more at www.abrdnjapan.co.uk or by registering for updates. You can also follow us on social media: Twitter and LinkedIn.

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