This stock market "is one of the most attractive in the world" right now

Ally Selby: Hello and welcome to the Pitch brought to you by Livewire Markets. I'm Ally Selby, and today we'll be discussing a market that Australians have ignored for more than three decades, Japan. Recently, institutional investors have been paying more attention to the market, so should you be doing the same? To find out, we're joined by June-Yon Kim from Lazard Asset Management. Thank you so much for joining us today, June. Really excited to have you here all the way from Tokyo.

For the first time in many years, Japan is dealing with inflation in addition to existing economic headwinds like an ageing population and supply chain challenges. How is the current economic picture painting your opinion of Japanese stocks?

June-Yon Kim: In many ways, some of the challenges that you mentioned, I view as tailwinds. For example, in terms of inflation elsewhere in the world, inflation is a negative, but for a country like Japan, which has been stuck or mired in deflation for the last three decades, normalising is a huge tailwind for Japanese companies. What you're going to see with the advent of inflation is a transformation in the economy in terms of how consumers behave, how companies invest, and also risk attitudes by the Japanese themselves. 

In terms of demographics, that is always a huge pushback when people have looked at Japan, but one of the things I think people should also note is when you buy Japan, you're not buying the country. You're buying these Japanese companies. The largest 400 companies in Japan, nearly 50% of their revenues come from overseas. If you believe the rest of the world is going to grow, these Japanese companies will grow as well.

The Japanese market has traditionally been fundamentally driven. Is that still the case today, and if so, what are two metrics that every potential addition to the portfolio must have?

Yes, very much so. Japan, in terms of the opportunity set, is probably one of the most attractive in the world, particularly in terms of developed markets. The reason why is historically it's been a very inefficient market, so for active stock pickers like ourselves, it provides a terrific operating ground for us to find undervalued, unappreciated names. 

Overall, what we're looking for in terms of names is limited downside. [We are] trying to understand what's been fully discounted. But on the upside, looking over the next three to five years, what's the story or trajectory that hasn't been discounted by the market? Is that asymmetry? It's that optionality that we're searching for as investors.

The Japanese benchmark has doubled in the last few years. Do you feel like it's becoming more sentiment-driven?

No, I think that doubling is just a reflection of the fact that fundamentals have been very strong. You've seen very strong earnings growth. What's interesting is the valuations haven't expanded that much overall, so I think in many ways, Japan's equity market growth - compared to other markets which have been more led by multiple expansions - has been much healthier overall in terms of equity market growth.

Your largest overweight today is financials. Why is that?

Financials would be the biggest beneficiary of that economic normalisation moving away from deflation. How that works is Japan's interest rates have been declining for the last three decades because of deflation. With the Bank of Japan now normalising policy, what you're going to see is an increase in policy rates. What that will translate into is higher net interest margins for banks, and as a result, higher ROEs, improving valuations for these Japanese banks if that transpires.

You also have large active underweights in healthcare and industrials. Why is that, and can you talk us through a few examples that you actually like within those sectors despite being underweight?

Mainly it comes back to asymmetry. Those are areas where we don't find a lot of individual stocks that offer that optionality, that asymmetry in terms of risk-reward. Having said that, within healthcare, particularly pharmaceuticals, the portfolio is overweight Takeda Pharmaceutical (TYO: 4502), which is Japan's largest pharmaceutical company by revenue. Takeda offers a lot of that asymmetry that we're looking for - limited downside in the sense that they are a high dividend payer. At the same time, we feel that their pipeline, particularly in terms of two drugs, really hasn't been appreciated by the market, and if we see positive developments in terms of phase two and phase three studies with their drugs, I think we will potentially see a revaluation of Takeda shares going forward.

For industrials, going back to what I said before, we don't see a lot of that asymmetry overall because the upside/downside equation hasn't made a lot of sense. But one name that we really do like is SMC Corporation (TYO: 6273). SMC is the largest pneumatic equipment company in the world. We feel that SMC can be a big beneficiary of a revitalisation in Chinese CAPEX, but also continuing CAPEX out of the US and Japan as well. 

Managed Fund

Lazard Japanese Strategic Equity Fund

Global Shares

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