A slow but historic transformation of capital markets in Japan is underway, according to Fidelity Portfolio Manager Masaki Nakamura, who says the Japanese government and stock market exchanges are helping to drive important changes to Japan’s Corporate Governance Code that he believes could benefit stockholders and result in potential investment opportunities.
“As part of a meaningful shift in corporate culture, the Tokyo Stock Exchange has urged companies to strengthen corporate governance and capital allocation procedures – and to communicate with investors more frequently,” says Nakamura, who manages Fidelity® Japan Smaller Companies Fund (FJSCX). “Private-equity investors and activist shareholders also are encouraging companies to improve in these areas.”
The portfolio focuses on the securities of Japanese issuers, and other investments that are tied economically to Japan, with a smaller market capitalization. Nakamura favors fundamentally attractive companies driven by an idiosyncratic catalyst, as well as quality companies with competitive advantages, a healthy balance sheet, strong free cash flow and a record of skillful capital allocation.
In recent months, he has sought to capitalize on the nation’s tighter focus on shareholder-friendly practices and corporate responsibility. “I’ve invested the fund in companies that have put in place stronger corporate governance procedures and are focusing on growing their returns on assets and invested capital,” he explains.
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As an example, he cites Nippon Concept, a founder-owned operator of tank containers that has carved out a niche in the domestic market, with 80% market share. This past summer, the founder decided to take the business private, allying with a domestic private-equity firm, according to Nakamura, adding that the purchaser offered a 37% premium to the closing price when the deal was announced. [Editor’s note: Nippon Concept was not held in the fund as of July 31.]
“This indicates that such a longstanding founder in a traditional industry is not afraid of privatizing the business to realize its intrinsic value, while working with a private-equity firm,” Nakamura says. “This would have been quite rare several years ago in Japan.”
Historically, Japanese companies were protected by having a stable shareholder base fueled by cross-shareholdings – a common practice in which publicly traded companies hold substantial stakes in other publicly traded companies. Now, however, the Tokyo Stock Exchange and the government’s Financial Services Agency require companies to unwind cross-shareholder relationships, leading to changing market dynamics. In response, companies are either taking steps to enhance shareholder value or they are delisting from the market.
Another company that has made significant improvement in corporate governance and enhanced corporate value is SWCC, a supplier of cable/power equipment, according to Nakamura. “It has a messy financial track record, but has significantly beefed-up corporate governance, adopting disciplined portfolio management to drive return on invested capital, streamlining unprofitable businesses and improving board structure,” Nakamura points out.
As a result, he says, SWCC has succeeded in improving its earnings power. SWCC was the fund’s largest holding as of July 31.
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Masaki Nakamura is a research analyst and portfolio manager in the Equity division at Fidelity Investments.
In this role, Mr. Nakamura manages Fidelity Japan Smaller Companies Fund. Additionally, he performs widespread fundamental research on Japanese small cap companies.
Prior to joining Fidelity in 2010, Mr. Nakamura was an assistant vice president at BlackRock in their global equity team and an assistant vice president at Merrill Lynch Investment Managers. He has been in the financial industry since 2002.
Mr. Nakamura earned his Bachelor of Arts in economics from Keio University and his Master of Business Administration in finance and strategy from The Wharton School of the University of Pennsylvania.