Unique Japan Macro Backdrop Attracts Private Credit, Equity Investors

Japan is navigating BOJ normalization, political change after recent elections, and ongoing corporate governance reforms. How are these policy shifts creating sector rotation opportunities and where are the best stock selection opportunities?

Michael Yoshino, Founder and Co-CIO, Pleiad Investment Advisors

We believe it is important to understand the macro environment and we have a view, but we invest from a bottom-up not a top-down perspective. The Japan macro environment we are seeing today is incredibly unique. Rising rates, inflation, rising wages and increasing labor shortages are elements we have not seen in over 20 years in Japan.

Some corporates can pass on price hikes while others are struggling given competition or saturation in their industries, which is creating a great stock picking environment. Corporate governance reform has been a buzzword for many years, but we think structural reform is still in the early stages and that is where we are seeing opportunities — companies are starting to understand it for the first time so that is where we see tremendous upside over the next 3 years.

Volatility has picked up especially in the AI space. How are you navigating these headwinds and what Japan specific risk management approaches are you employing?

Japan equity performance has been very concentrated, and the Nikkei has become a pseudo-AI index — three stocks (Advantest, Softbank Group, and Tokyo Electron) in the Nikkei 225 carried a 30% weighting as of the end of October and drove over 60% of year-to-date returns at that point. Many of these AI names are quite expensive, very crowded, and have high momentum with short-term money chasing them. As part of our portfolio construction and risk management process, we monitor these factors and positioning.

We don’t pair trade or short for the sake of hedging, all our short positions are intended to be alpha shorts. We monitor factors and positioning to avoid crowded longs and shorts which helps to manage through periods of extreme volatility.

We have built an internal data-driven system, pulling in short interest data from our prime brokers, profiling the type of investors in each stock, and we also crawl local chatboards to gauge sentiment by creating heat scores on each name.

How has your Japan investment strategy evolved over last 12 months?

The equity market in Japan has changed considerably over the past few years and so have market participants with the rise of platforms and an influx of Asian investors into Japan. There are more short-term high level thematic investors who can’t typically perform due diligence on the ground. We have developed Asia-centric thematics, which help us to identify areas to focus on and then we build conviction on the best names from a bottom-up perspective. On the short side, with the rise of activists and more take-privates in Japan, we have also adopted custom short baskets of four to five names to express a short view and capture alpha while removing some of the tail risks of an activist campaign.

What opportunities are you watching over the next year?

We are focusing on the ongoing and worsening labor shortage in Japan, which will force companies to automate and use AI. As Japan is at least two years behind the US on AI adoption, when these solutions get deployed, we think it will trigger a lot of market dislocation, creating both winners and losers.

How are private credit deals in Japan evolving with monetary policy?

Siddhartha Hari, Co-Head of Private Credit - Elham Credit Partner, Hillhouse Investment

Value transfer is the key driver. The first wave of private credit in the US was post 2008 when banks pulled away, post the GFC. But the real explosion in this space was when US rates went from 0–5% in the US as you suddenly saw 5% of value transfer from shareholders to creditors, which is a very big swing.

We are now starting to see that in Japan following the upward moves in rates. New sectors are coming into play such as energy transition, power and digital Infrastructure. Nascent shifts in technology are also conducive to private credit so those are the sectors we are starting to see in Japan.

How different are private credit markets in Asia and Japan versus the US and Europe and what do investors need to understand about these regional differences?

The US is a mature market with multiple managers on every deal. Asia private credit tends to be more bilaterally negotiated, so most deals do not go to press. The Asian deals offer more non sponsor opportunities, typically with lower leverage, better covenant protection and more bespoke structuring.

From an allocator standpoint, as an example, almost 80% of public bonds in Japan are investment grade and nearly 50% are single A, where the coupons are at multiyear percentage lows. The returns that private credit can generate in Asia versus the public market and even the US direct lending market is significant. Japan pensions are good examples, as they represent a $2 trillion industry. You are seeing more activism and the need for higher return on capital as the industry moves toward more investment-linked rather than savings-linked products.

What strategies are you most interested in right now and how are you structuring for investors in this environment?

Theresa Han, Managing Director, GCM Investments HK Ltd

We build portfolios of hedge funds for investors, so we don’t want to take market directional risk. Even though valuations in Japan are not as stretched as other markets, we want to maintain stable returns.

We favor event-driven and corporate governance type strategies and stock picking which is better than it was three years ago. We identify the best manager for each strategy and aim to build a portfolio with managers having low correlations to each other.

Do you see any differences in investing style between Japanese and non-Japanese investors?

Japanese investors identify trends in a new regime earlier. They believe in the domestic reforms and have embraced corporate governance strategies, which they perceive to be low-risk weight (for banks subject to Basel rules) and high alpha. Offshore investors also started investing in engagement strategies a few years ago and have been increasing focus on fundamental long–short stock picking.

US endowment firms coming to Japan are looking for concentrated, multi-year-investments similar to what they have found in India and China. They don’t mind volatility as they have a long-term investment horizon but looking at the universe of funds in Japan, the environment is not as mature as growth companies have been in short supply.

For more information on this topic, please contact Jun Yunoki