A Sustainable State of Mind

There is an once-in-a-lifetime transition underway from volume to value that is creating new investment opportunities in the Japanese equity market. The corporate governance reform and Japanese population dynamics have played a key role in catalyzing this transition to a value-oriented mindset. As an investor, SPARX Asset Management plays an important role in helping companies understand this change, and we observed lately that Japanese companies are becoming more receptive to engagement with investors like us.

When you consider investing in Japanese equities, you cannot ignore the infamous “Lost Two Decades” – the years between Japanese equity market peak in December 1989 (as measured by Nikkei 225 Index) until 2012, when the former Japanese Prime Minister Shinzo Abe set forth his Abenomics stimulus policies. Why did the market struggle for so long, and what did Abenomics change?

The return of shareholders

Shareholders were absent for a staggering 70 years in Japan. From the end of World War II – which saw a transition from shareholder to bank governance – until the implementation of Abenomics, the concept of shareholder value did not exist. Abenomics, however, opened the door for shareholders to make their way back into Japanese corporate governance sphere. Corporate Governance Reform started in 2013 and since then, the results have been noticeable. For example, in the Tokyo Stock Exchange First Section with over 2,100 listed equities, the percentage of the companies with two or more independent directors was 18% in 2013; as of August 14, 2020, that number had dramatically increased to 95.3%. Global investors have recognized that Japanese corporate governance has changed for the better, as well.

为什么股东缺席现场超过70年？第二次世界大战是从股东转型到银行治理的原因。在战争之前，私营部门实际上可能是令人惊讶的是，私营部门实际上是日本公司最大的单一股东。一些公司团体，如三菱或三井，那时非常强烈。但为了为战争做准备，日本政府实施了受控的经济模式，并获得了私营部门的股份。在战争的后果中，公共部门成立于1947年最大的单一股东，政府利用金融部门将资本转向战略部门，如材料植物和重工业。这导致金融机构于1989年成为最大的股东。当泡沫破裂时，银行股权减少，私营部门 - 外国和个人投资者 - 增加。从那一点到直到前瞻性的过渡期，没有影响市场的单一主要因素。经过20岁的过渡期后，私营部门现已达到50％的企业日本股权，股东结构变化与私人股东最终作为主要行动者返回的私人圈子。

The bank-led governance model worked well under the volume growth era underpinned by population and demand growth. Japan’s population steadily increased for 140 years until 2008. In 1868, when the Meiji Restoration occurred, and the Era of Samurai Warriors ended, the population was around 30 million. It increased fourfold into the first decade of the 21st century. The banks’ business strategy worked well under the volume growth economy as banks simply wanted to increase lending volume without considering the cost of capital. But after population growth peaked, this model ceased to work. A declining and aging population characterized by labor shortage is one of the key social issues in Japan and is forcing the government and corporate management teams to revise their growth strategy going forward. From an annualized population growth of 1% in the period between the 1950s and 1980s, Japan now faces declining population growth of -0.10%.

一个人口下降的开始value growth era and a change in the focus of management and employment styles across Japanese companies. Labor market conditions have also changed from aggressive hiring during the population growth period to over-employment during the lost two decades, and now finally labor shortage. Management focus started with a priority of increasing volume, then to cost-cutting, and now finally to adding value. In Japan, labor mobility has been low due to regulation, so that companies could not downsize in the over-employment regime, forcing many to follow a business diversification or low-price strategy, with cost-cutting. But after 2010 with a wave of baby boomer retirements and a declining youth population, the Japanese market suddenly switched into labor shortage paradigm, and companies have begun seeking value adding strategies.

In that context, what are the questions management should be asking? Under this new paradigm, the quality of governance is key to creating value. Can the management tackle the labor shortage problem by improving productivity? Can they focus the business on its core competence to strengthen corporate brand value, and take advantage of industry consolidation as less productive firms exit their sector? In order to successfully transition to value-added model, a shareholder’s mindset is an absolute necessity.

To address that mindset, it is the sincere desire of SPARX to contribute to the improvement of ESG issues and investing in Japan, and we are using our position as the largest independent asset manager in Japan to engage with companies on that topic. We believe this can impact global ESG improvement and lead to positive strategy returns for our investors. With more capital and advice from global institutional investors, our impact can be very significant, and we appreciate their continued support for our activities.

出现的证据表明，随着时间的推移，ESG动量可以是alpha的重要来源。这一前提确定了一家公司ESG基础知识的变化的因果关系，最终反映在其ESG分数，及其未来股价绩效。这可以通过增加盈利能力和/或减少折扣率来进行。因此，通过识别ESG基本面的变化，投资者可能能够增加“通过做好事做得很好”的机会。

环境、社会和治理分数分配给公司在这是有用的s regard, but like any other scores they come with challenges in terms of availability, accuracy, and consistency. For example, the number of companies covered isn’t maximized given limited disclosure, especially in Japan. Most importantly, just like financial information, scores themselves may be priced in as soon as they are released. Ideally, therefore, any underlying structural change in ESG fundamentals should be identified before it is reflected in ESG scores. This is easier said than done, however.

In practice, there should be a significant time lag between the underlying structural change in ESG fundamentals and the resulting change in ESG score (see in figure 1). While some firms may simply need to better understand rating agency requirements, others are required to engage in long-term structural reform which, if identified early on, can allow investors to benefit from increasing valuations. Therefore, long-term perspective is essential.

Further, faced with a large investable universe, identifying which companies are most likely to benefit from ESG momentum is daunting – especially in Japan, where the universe contains more than 3,700 listed companies. The task is made even more difficult by Japan’s unique corporate culture and language barrier. Long-term experience in direct fundamental bottom-up research is therefore essential.

Yet many of these changes may not materialize despite the best intentions of corporate management. Some Japanese companies that would like to embark on ESG strategies just don’t know how to get started. In addition, new and improved ESG strategies are often met with skepticism by investors, which may discourage companies from proceeding. But when a company’s management expresses a desire to improve its ESG fundamentals, they are often more receptive to advice from investors like SPARX Asset Management, which in turn can help influence investors who, through active engagement, may be able to dramatically raise the chance of a company making real progress over the long run.

A fundamental approach

为了利用ESG机会，通过长期投资地平线的基本自下而上的股票拣货机扮演一个重要的作用。事实上，Sparx强烈认为，结构理解，自下而上的股票选择和积极参与的组合可以捕获日本公司的ESG势头，如下所示。

Essentially, through fundamental bottom-up research we capture in advance what we anticipate ESG scores could be in the future, and apply the structural relationship that we learn to make a long-term financial forecast to estimate the intrinsic value in. Let’s take a deeper dive into the above illustration.

• Non-financial Information at T-1 to Financial Information at T (A)
  我们首先了解ESG，盈利和资本成本之间的关系。为此，我们会检查过去的非财务信息，包括综合报告，网站，第三方ESG分数和其他公司/竞争对手案例，基于我们30年的经验。

• Non-financial Information at T-1 to Non-financial Information at T (B)
  我们通过以下最新新闻发布和开展会议检查ESG的任何变化。我们与公司IR团队与管理层会面，如果可能，检查其ESG活动的未来方向。因此，我们经常会注意到公司发生的变化。大多数资产经理和投资者只使用量化筛查，可能是因为他们不能或不做我们所做的那种定性工作。在这一步骤中，我们的文化和历史的差异是显而易亚慱体育app怎么下载见的。

• T + 1（c）的非财务信息到金融信息
  We utilize what we learn to make a mid- to long-term financial forecast. Through IR meetings, we check whether the management strategy integrates ESG factors, and the team discusses the feasibility of the management strategy based on their track record. For more than 30 years, SPARX’s investment approach has focused on qualitative aspects of the underlying business fundamentals to make long-term forecasts. What we do today with ESG is a natural integration with our investment approach over a 30-year period.

Role of Active Engagement

Throughout our investment process, we believe that active engagement plays an important role in raising the chance of a company making real progress over the long run.

We place tremendous importance on discussions with companies to determine if they have built a foundation for sustainable growth by establishing strong relationships with shareholders, employees, business partners, local companies, the global environment, and all other stakeholders. If we see the potential for improved corporate value as a result of these dialogues, we demonstrate our support for management by actively investing in such companies. When necessary, we exercise our shareholder rights during general shareholders' meetings to actively motivate corporate management. Conversely, if after such discussions a company makes no changes to a management strategy that hinders sustainable growth, then we end our investment by selling all shares to protect the profits of the strategy’s investors. In short, our engagement activities revolve around dialogues that are meant to build strong relationships with the companies in which this strategy invests.

The adoption of coaching elements in our discussions has been particularly effective. Coaching is a communication skill meant to motivate the other party, and it helps spur investee companies to become more active because of our meetings. Based on the awareness levels of a company’s executives and IR managers and the specifics of its management issues, we determine whether coaching is appropriate (there are situations in which it could be unsuitable). When appropriate, we ask companies a series of questions to have them set goals, to consider their current situations in regard to these goals, and to create action plans to fill the gaps. After these meetings are over, companies reflect on their new insights, and if they ask for our opinion, we provide it. For the last couple of years, most discussions have been on ESG-related matters, and some of the companies with which we have spoken have held ESG briefings or improved their integrated reporting processes. These are the results of forward-looking corporate actions.

We expect two major types of results from our engagement – improving fundamentals and eliminating the value gap. The key issues for improving fundamentals are business models, financial strategies, and ESG strategies. Because these are companywide strategies, it is challenging to encourage change when top executives are not conscious of these issues. On the other hand, it is effective to back companies that are already highly aware of these issues. “Eliminating the value gap” means to eliminate a situation in which, for some reason, a company’s share price is lower than its intrinsic value. The main issues in such situations are IR strategies, ESG information disclosure, and corporate brand strategies. To create awareness among top executives, practical IR activities are also a key element, so we emphasize discussions with IR managers as well as with executives.

So far, our discussions as described have shaped our view of sustainable investing in two ways. First, companies with the potential to improve their ESG fundamentals are often undervalued and should therefore provide opportunities to generate unique alpha. Second, we advocate an integrated ESG approach where fundamental bottom-up analysis includes ESG considerations with active engagement. This resonates with SPARX’s fundamental bottom-up stock picking approach with a long-term mindset.

CASE STUDY: NINTENDO

Since its founding in 1889, Nintendo has operated a business centered on developing and manufacturing entertainment products. As expressed through its CSR policy of “Putting Smiles on the Faces of Everyone Nintendo Touches,” Nintendo’s history is one of growth through getting more people involved and making them happier.

任天堂volati往往有显著的收益lity, depending on the success of its entertainment products. For example, the firm had three consecutive years of losses (FY3/2012 through FY3/2014) due to the subpar sales performance of the Wii U, the successor console to the blockbuster Wii. From an investor’s perspective, the stability and predictability of Nintendo’s earnings structure are causes for concern, and that has impacted SPARX Asset Management’s decision to make the company a long-term investment.

More recently, SPARX began to reconsider investing in Nintendo, seeing signs that business and external environmental changes over the past five years could contribute to improved profitability and growth potential for the firm. In 2015, under a new company president, the firm revised its basic policy from expanding the gamer population to increasing the number of people who enjoy Nintendo content. The strategy increased focus on Nintendo Switch, specifically its lifecycle and user engagement, launching new titles on a schedule that sustains business momentum. In the process of achieving this, Nintendo combined two separate development systems – one for handheld systems (like Nintendo DS) and one for consoles (like the Wii) – to concentrate its resources on the Nintendo Switch. The company has also created new revenue streams through online membership services and by launching a new revenue model based on membership fees.

In the course of its research into Nintendo, SPARX discovered that changes in the external environment were beginning to provide a tailwind for the company, as well. For example, in 2019, its lead developer, Shigeru Miyamoto, was selected as a Person of Cultural Merit, an official Japanese honor awarded to those who have made outstanding contributions to the nation’s cultural development. This signaled that gaming is starting to gain cultural credibility. In addition, the COVID-19 pandemic has created a need for people to relieve stress while they are stuck at home. The World Health Organization (WHO), which once warned about gaming addiction, has reversed its position and started a campaign to promote gaming.

基于其研究，Sparx观察了任天堂经济价值的变化。新的管理团队改变了公司的运营质量。运营变化导致了关于延长产品生命周期和提高用户参与的具体战略决策，并通过更高的盈利能力和更稳定的性能，该公司开始提高其盈利质量。此外，大型社会越来越越来越认识到比赛的文化方面及其价值作为通信工具，导致比以前更大的媒介长期市场增长潜力。

最后,在投资任天堂之前,SPARX计算lated Nintendo’s corporate value to reflect the factors mentioned, and concluded that it is higher than the company’s share price. In doing so, SPARX raised its earnings forecast for Nintendo, taking into account market growth and higher profit margins, and also lowered it discount rate to reflect the decrease in the earnings volatility risk factor.

In the process of helping his parents evacuate Fukushima after the twin disasters of tsunami and a nuclear power plant accident, Yu Shimizu thought a lot about sustainability – why it mattered, what more needed to be done. The next year, in 2012, he launched the Japan Sustainable Equity Strategy and became its lead portfolio manager, at SPARX Asset Management. The team he leads does rigorous work reviewing Japanese companies one by one, looking for stocks in companies that are on the path to becoming “sustainable”, where the stakeholder value of which enhances its economic value. In his role, Shimizu views himself as a bridge between the world’s investors and Japan. II recently chatted with him about the unique aspects of Japanese businesses, and entrepreneurial spirit that pervades at SPARX.

What is the overall philosophy behind the Japan Sustainable Equity Strategy?

Its aim is the sustainability of three elements – the world, the investment chain, which includes the companies we invest in and asset owners, and our own activities. Our vision is to make positive contributions to a better investment chain where our investments help to build a better society and successful, growing businesses.

全球投资者应该不是深深fa是谁miliar with Japanese companies know about them and their approach to sustainability?

Japanese businesses have had a sustainability-like mindset much longer than you might expect. There are about 2,000 companies in the world with a history of 200 years or more, and 65% of them are Japanese. One reason so many Japanese companies thrive for long periods of time is the philosophy ofwhich means three stakeholders benefit from a business – seller, buyer, and community. For a long time that was the de facto solution for corporate governance. But actual shareholder rights lagged behind, because what we today refer to as a public company didn’t exist in Japan until 1865 – several centuries after European stock companies came to be. Shareholder rights were unclear in Japan for a long time, but there has been a lot of progress in that regard in recent years.

But we have much more to do. For example, as is the case with many countries, the Japanese people prioritize domestic issues. In terms of the supply chain, people monitor the domestic labor situation very strictly, but they don’t pay much attention to the labor situation in overseas factories.

What are the criteria used to determine which businesses to include in the strategy?

We view a business as sustainable when they create stakeholder value which enhances their economic value. We are not investing only in companies with perfect sustainability records. We also look at their potential and whether their ESG fundamentals are improving. One reason we look for businesses that are improving is valuations – companies with sterling ESG records are likely to be very expensive. Another, more important reason is that to help build a good society, we need to help the company that lags behind. In other words, we need to be forward looking and inclusive.

What are some signs of potential that you think indicate a company is improving its ESG profile?

Most common sign is the change in governance, and we try to capture the ripple effect from this. To do so, we view the stakeholder value holistically and structurally. Governance is the center of the stakeholder value, and social and environmental spread outward from there. Our definition of social is the direct stakeholders who have a relationship with the company – employees, suppliers, clients, and the local community. Environment is beyond social and therefore global. For example, a Japanese company and Brazilian forests are not directly connected, but the forest is s stakeholder all the same.

Being a Japanese asset manager must make those meetings with corporate leaders more productive. What are you looking for in the leadership?

The top management is very important as we consider an investment as is the support system for them. The improvement of a business’ fundamentals and the actions it takes depend on top management and how they motivate the employees. We like business leaders who are visionary, sincere and can clearly explain their rationale – we’ll take those traits over charisma any day. We do not like dictatorial leadership – we like leadership that is perceptive regarding stakeholders’ opinions, including ours. We also introduce our coaching methodology into conversations with the companies to let them know that we can help them improve. The purpose is to provide new information and awareness to the companies. For example, some companies are having ESG meetings after we suggested it. In another case, when activists were creating issues, we suggested the management that a vision statement would help, and the CEO sent a letter to investors as a result. Another company abolished its poison pill policy after our recommendations. We do discuss their ESG score, but today companies recognize it’s not just about the score – they need to improve their business activities or management strategy itself.

What led to the coaching approach?

Sometimes a person’s inner opinion differs from their outer opinion. The Japanese people do not like tough negotiation, so if we spoke too strongly to a business leader they may choose to close their mind and hide their inner opinion. If we ask them a very open question and then listen carefully and acknowledge their answer before providing feedback, then we can build very good relationship that allows us to better understand how the business is doing.

Why should a European investor consider it important to include Japanese companies and their sustainable strategies in their portfolios?

For starters, diversification and impact. Our Japan Sustainable Equity Strategy should be a good diversifier to mitigate risk of investing only in, say, “ESG Developed” region like Europe. Also, many European countries are very advanced in terms of ESG, so investing in Japan, which may be called “ESG Emerging” country, can help the world move forward toward greater sustainability.

Putting ESG aside for a moment, the Japanese stock market is relatively less efficient, so it adds a non-correlated pursuit of alpha. Our strategy’s alpha is mainly generated by stock selection. We do not bet based on sectors or size, which means you can enjoy unique alpha potential that is the result of our bottom up research capability.

What companies might investors be surprised to find in the strategy?

If you simply look at a sector or a business on the surface, some companies may not have a great ESG image. But we take a much more holistic view to understand the relevant trade-off. To illustrate, let’s take an air conditioning manufacturer that we are investing. First of all, they have an environmentally friendly technology. Second and perhaps a subtler consideration is the role air conditioner plays to solve global economic inequality by increasing the productivity of regions with tropical and subtropical climate. There is also an increasing risk of loss of lives as heat waves become more severe with global warming. This company fully recognizes its social and economic benefit, while minimizing the cost to the environment.

What do you see as the big differentiators for SPARX and the Japan Sustainable Equity Strategy?

We are based in Japan and we speak Japanese, so we are very good counterpart for companies we invest in. Our client base is global, and we have implemented global standard strategy quality, especially regarding ESG. We have been disclosing the strategy’s ESG score for greenhouse gas emission on a monthly basis, for example. And we’ve analyzed the future scenarios of climate-related risk in line with the TCFD format. Our team working on the strategy is very diverse. Nearly half of our team are women. Nor is everyone on the team Japanese. We believe that helps with better idea generation and decision making.

另一个重要优势是我们是独立投资公司。在日本，许多投资公司都是较大的金融集团的一部分，或者他们有一些类型的股权或利息可能在最前沿可能不清楚，但它在背景中存在。因此，像我们一样独立，随时为30年，如果有的话，这是一个非常庞大的资产管理人员。我们公司的基础哲学是，每个人都应该提出自己的投资假设，并以积极的，高信任方式寻求对应的投资。每个投资组合经理都有完全自行决定投资，因为他们认为在他们管理的投资组合中有适合 - 没有买到或卖出的压力。我们的策略也是全面的策略，我们的同事管理其他全面资金，我们每天都有团队会议。但重量平分行为小于20％，这表明我们的人民真的在思考和行动。在这方面，我们认为我们比任何其他日本资产管理人员更具企业化。

What’s your goal as the leader of the strategy?

We want to be the bridge between Japan and overseas investors. To pursue that goal, we make every effort to build a high-quality Japanese equity strategy in line with the European standard for ESG. It’s not only about the performance, but also the reporting. We are writing monthly reports showing the data and explaining our activities, such as going into great detail on dialogue with the companies in the strategy. We also published the strategy’s annual report, which is very unusual in Japanese asset management. We are very open-minded and receptive to feedback from asset owners and the leadership at companies which we invest in. Ideally, we’d like more and more asset owners to read our reports and give us feedback, so that together with global investors we can contribute to global ESG development from Japan.