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This article first appeared in the Telegraph
At the age of 90, Warren Buffett has clearly not lost his contrarian streak. Buying significant minority stakes in five Japanese trading companies is an unexpected move. But there is method in the Sage of Omaha’s madness and the investments may be simpler than they look.
Investing in Japan has been a niche pastime for years. Most investors decided long ago that this was a market they could safely ignore. Worth less than 7% of the total value of global shares, the Tokyo market remains well below its 1989 peak as investors have shied away from its notorious three Ds: deflation, demographics and debt.
No investor has lost their job for failing to take part in the periodic revivals of interest in the Nikkei. They have all petered out long before any awkward questions have been asked. As one of my colleagues used to remind younger investors: it’s never too late to short Japan.
I love the country, having spent a happy year teaching there after university. But even I have to recognise its flaws. Japan has an ageing and shrinking population; it has a sclerotic workforce, held back by outdated working practices (particularly for women) and a deep-seated aversion to immigration; it has failed for years to generate even mild inflation; and it labours under an unbearable weight of borrowing. No wonder investors have kept away.
Investing in Japan this year looks even more eccentric than usual. The architect of the economic reforms that have come closest to getting Japan back on a growth tack, Shinzo Abe, has just stepped down as Prime Minister after eight years. The spirit of Abenomics may survive but without its guiding light Japan may slip back into its old corporatist ways.
This is the back drop to Buffett’s significant bet that Japan can finally defy the sceptics and regain its 1980s mojo when the bookshelves were full of breathless titles like ‘Japan as Number One’ and ‘Japan’s Economic Miracle’. It may be a small slice of Berkshire Hathaway’s $147bn of spare cash but $6bn is serious money in anyone’s book. Buffett has clearly thought this through.
On the face of it, the five century-old trading houses - Mitsubishi, Mitsui, Itochu, Sumitomo and Marubeni - are an odd choice for an investor who has long made a virtue of investing in what you understand. The companies are notoriously complex, with a web of cross-shareholdings. They do not have a great track record of returns - failing to even match their cost of capital in most cases. And they are dependent on cyclical, resource-focused operations for a large part of their profits. Other parts of their businesses in machinery, food and retail have suffered during the pandemic.
But to an extent this is the point. The businesses may be sprawling and deliver unexciting returns, but they are solid and stable, with a big international reach. And they are undervalued, partly thanks to their complexity. Most investors just can’t be bothered to understand what’s under the bonnet. Most of the houses trade at less than their book value. In this regard, they are a classic Buffett investment, the kind of share he learned about from his mentor, Benjamin Graham.
In a world in which the growth investment style has prevailed for years, Japan is the ultimate value investing market. It is perhaps inevitable that Buffett, in search of a home for his embarrassingly large cash-pile, should have crossed the Pacific.
Buffett’s wager on Japan should also be seen as a bet against his home market. It is no coincidence that news of the five trading house stakes should have emerged in the same week that the Nasdaq index of mainly technology-focused stocks should have fallen into correction territory, down 10% from its peak in a matter of days.
The echoes of 1999 are loud and clear today as Apple’s value eclipses the whole of the FTSE 100 or all of the Russell 2000 index of smaller US shares. Just the biggest five technology companies in America now account for nearly a quarter of the value of the S&P500. The valuations of the top 10 tech stocks are within a point or two of the peak levels reached at the height of the dot.com madness. Buffett has been around long enough to know that this kind of excess does not end well.
At its heart, this is a simple carry trade for Buffett. Alongside the purchase of the five stakes, Berkshire Hathaway has issued yen-denominated loans for the first time, enjoying the company’s ability to borrow at a cost just 0.4% higher than the Japanese government itself. If you judge, as Buffett clearly has, that the complexity and trading challenges of the companies are more than priced in today, then their safe dividend yields of more than 4% look like so much free money. If these global dealmakers bring a steady stream of investment ideas the way of one of their leading shareholders, well so much the better.
So, should we follow Buffett into Japan? Notwithstanding the many challenges facing the country, it should have a place in any well-diversified portfolio. It is cheap, at around 15 times expected earnings compared with 21 in America, it is politically stable, has dominant positions in many key industries of the future like robotics and industrial automation, and it is a great play on a global recovery from the pandemic.
The US is pricey, Britain is bogged down in Brexit and Europe is battling with the second wave of Covid-19. Now more than ever, dull old Japan looks like a safe haven. Just what a smart 90-year-old contrarian might conclude.
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.