Matthews Japan Fund First Quarter Commentary
Japan’s equity market extended its late 2012 rally as investors anticipated a potential revival of the Japanese economy led by aggressive fiscal and monetary policies. Overseas investors poured nearly US$40 billion into Japanese equities during the quarter while the yen continued to weaken, falling by almost -8%, and raising the export sector’s outlook on profits. In addition, a stronger U.S. economic recovery, coupled with further Bank of Japan (BOJ)(JAS:8301) expansionary policies, has left signs of nascent economic activity.
Two notable events during the quarter included the appointment Haruhiko Kuroda as the Bank of Japan’s new governor and decisive action by Prime Minister Shinzo Abe to enter global free trade talks. Kuroda, who previously served as president of the Asian Development Bank, was a leading critic of the BOJ’s passive monetary policies. During his confirmation process, he repeatedly stressed his intent to expand the monetary base and realize an inflation rate of 2% within two years. The exact inflation target that Japan may actually reach is somewhat less important than the fact that the BOJ, which has historically been reluctant to commit to policy targets, has resolved to aggressively pursue various monetary options to try to battle deflation. This appears to be a positive step even though it will take time to shift the deflationary mindset of Japanese consumers and corporate management.
Prime Minister Abe’s recent decision to take part in global trade talks may be a catalyst for reforms, including the deregulation of certain industries, such as agriculture and insurance. The economic partnership may also lower trade barriers amongst participating countries and heightened competition with foreign firms may trigger much-needed consolidation in various industries while lower trade barriers could increase Japanese exports and services. Abe’s decision to join the talks is widely opposed by Japan’s rural voters, a long-standing support base for Abe’s Liberal Democratic Party, while many others herald Abe for showing strong political leadership, something Japan has not had for many years.
Given the developments in Japan’s economic and political outlook, we made changes to the portfolio during the quarter. Most notably, we increased exposure to select Japanese banks for the first time in many years. With domestic loan demand having shrunk during Japan’s previously deflationary environment, we had been wary of Japanese banks. However, we now believe there is potential for loan demand to grow as Japan moves into a negative interest rate environment in which the expected rate of inflation exceeds nominal loan rates. Additionally, Japanese banks have accelerated loan growth in overseas markets, particularly in Asia, as struggling European banks pull out of the region and shed assets to comply with more stringent capital requirements. With higher credit ratings and robust capital positions, Japanese banks are in a strong position to expand lending and associated financial services in Asian markets. Valuations for select Japanese banks have also been attractive relative to global counterparts despite the improving fundamental outlook.
During the quarter, three of the top contributors to Fund performance were domestically oriented Japanese companies including JP-Holdings (TSE:2749), a leading operator of child care facilities, and Internet services companies GMO Payment Gateway (TSE:3769) and Kakaku.com (TSE:2731), which continued to deliver solid operational results. JP-Holdings did particularly well following the passage of new government measures to expand subsidies for child care facilities as the country seeks to increase female labor participation and raise its birth rate.
In terms of detractors, robotics company FANUC (TSE:6954) posed the biggest drag on Fund performance for the quarter. Fanuc’s share price was bid up toward the end of 2012 but fell again during the quarter as demand for its products, most notably from China, remained weak. Demand for robotics tends to be cyclical, and we continue to hold FANUC as it remains an attractive global competitor in this field.
Looking ahead, we are encouraged by the developments on both monetary and fiscal policies, as they may finally move in tandem to overcome deflation. There are already signs that capital allocations in Japan are shifting, particularly from an increase in real estate transactions. Though we realize that there are no immediate cures to Japan’s structural issues, such as its aging demographics, we feel a sense of optimism that the country has moved in the right direction and that there are attractive opportunities to invest in fundamentally sound businesses at reasonable valuations.
The views and opinions in this commentary were current as of March 31, 2013. They are not guarantees of performance or investment results and should not be taken as investment advice. Investment decisions reflect a variety of factors, and the managers reserve the right to change their views about individual stocks, sectors, and the markets at any time. As a result, the views expressed should not be relied upon as a forecast of the Fund’s future investment intent.
Statements of fact are from sources considered reliable, but neither the Funds nor the Investment Advisor makes any representation or guarantee as to their completeness or accuracy.
As of 3/31/2013, the securities mentioned comprised the Matthews Japan Fund in the following percentages: JP-Holdings, Inc. 3.0%, GMO Payment Gateway, Inc. 2.0% Kakaku.com, Inc. 1.5% and FANUC Corp. 1.9%. Current and future portfolio holdings are subject to risk.
Performance and distribution figures discussed in any of the Manager Commentaries reflect that of the Investor Class Shares.