The Emperor’s New Jeans
This post first appeared in the "Shareholder Activism - A Monthly Snapshot"
A new era for activist investing in Japan.
Shareholder activism took its earliest forms in the 1920’s in the US when Warren Buffett’s investing mentor, Benjamin Graham, launched his shareholder activism campaign against Northern Pipe Line Co. Over the past ninety years, activist investing has evolved in a considerable way. With prominent industry figures like Carl Icahn being described as “Hollywood Material” by the media, these outspoken US investors have forged themselves an image that is more akin to movie stars than financiers. And like many things hailing from Hollywood – the trend has caught on, making US-style activism one of the most popular business exports around the world.
One of the first foreign destinations where this caught on in a substantial way is also home to the world’s last living emperor: Japan. With trillions of dollars on the balance sheets of Japanese corporates, the country presents a wide playing field for those investors daring enough to take on a conservative system characterised by male-dominated boards, and a media that is often described as timid and complacent.
According to joint research conducted by the University of Southern California, Kobe University and University of Virginia, between the years of 1998-2009, (the first ten years when US-style activism arrived in Japan) barriers to entry were at historically high rates. The presence of “insiders” on the boards of companies, the large quantities of passive domestic investors and a sceptical attitude towards any outsiders wishing to “disrupt” business in Japan created a challenging environment for investors looking to employ the mechanisms of their US counterparts. David Herro, who runs the $29bn Oakmark international Fund at Harris Associates described Japan by saying it is “30 years behind its peers in how its companies are run.”
However, a change in government, led by Prime Minister Shinzo Abe, led to a raft of critical corporate governance reforms which paved the way for numerous activist success stories in the country. Called “The third arrow of Abenomics” to refer to reforms aimed to make the economy more productive, Abe implemented it in order to encourage institutions to become more actively involved in the companies in which they invest. This led to more than 100 investors signing Japan’s stewardship code, titled “Principles for Responsible Institutional Investors,” and introduced an index of 400 Japanese companies doing a good job of providing returns on investment.
The “third arrow” opened up the Japanese corporate environment and paved way for recent success stories including Third Point CEO Dan Loeb’s historic victory at Seven & i Holdings Co.(Japan’s largest retailer and owner of 7-Eleven in Japan) where he succeeded in prompting long-standing CEO Toshifumi Suzuki to step down. Just a year prior to his remarkable triumph at Seven & i., Loeb added another string to his bow when he successfully challenged Japanese robot maker Fanuc to use its enormous cash pile to buy back more shares. Fanuc proceeded to lift its dividend and boosted its payout ratio, prompting the Japanese stock market to surge.
Amidst all this positive change, the country still operates under a different set of rules depending on whether it is a local or foreign activist waging a campaign. Strict societal norms and business etiquette have meant that local Japanese businessmen must opt for a far friendlier approach than their foreign peers. Masaki Gotoh, CIO at Misaki Capital, which launched its first fund in 2014 and now manages some $300 million, doesn’t subscribe to the policy of publishing open letters and has never publicly spoken out against a CEO. He has been quoted as saying, “Dan Loeb got away with it because he’s a foreigner. If I tried to do that, I would never be able to do anything ever again here in Japan, because I’m a local and people would basically say, ‘You should know better.’”
Other pioneers like Tsyoshi Maruki, have been more rebellious in following the social norms that are so heavily embedded in the local business culture. Since creating Strategic Capital Inc. in 2012, he vowed to swim against the tide and to speak out if he disagreed with the management team of one of his targets. His credo is, “If one always adopts a friendly engagement style, such as having gentle and warm meetings, would the management really change? After the meeting, it would probably end at a comment like, ‘They were nice.” Strategic Capital has posted strong returns over the past couple of years.
If Japan has demonstrated one thing throughout its young history in shareholder activism, it is the country’s remarkable ability to continuously reinvent itself. According to 2015 Preqin figures, of the activist funds launched, 22% were Japan-focused. Perhaps, Japan’s biggest rock star Yoshiki Hayashi is right, “The past can be changed by the future.”