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Danger & Opportunity: The Silver Lining

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Tokyo-based SPARX Group was founded in 1989 by Shuhei Abe, who has since grown the investment firm into one of Asia’s largest asset managers (and its largest hedge fund complex). A public company with offices around the world, SPARX offers its Asia and Japan mutual funds in the U.S. through its SEC-registered RIA, SPARX Group Co., Ltd. Abe has steered SPARX through several business cycles, and in particular weathered the “lost decade” in Japan: the 1990s. IA Editorial Director Jamie Green conversed with Abe via e-mail to share the investment lessons he’s learned.

With troubled banks not lending, some people worry that the U.S. could be headed toward a decade like the 1990s in Japan. How difficult was it to find good investments in Japan through the 1990s, and what are the lessons for advisors?

The 1990s were a time of crisis in Japan, when many of the preconceived notions that investors took for granted were challenged by the difficult economic conditions. In that sense, it is very much like today. When markets experience sharp declines, people have doubts about the future, and it is hard for investors to maintain discipline. But it is also at these times where disciplined, experienced, and focused investors can find the best investment opportunities.

The bursting of Japan’s real estate and stock market bubbles signaled the beginning of the end for “Japan Inc.,” where the economy was managed from the top down with the bureaucrats and banks controlling the system. As the banks worked to resolve their bad-debt problem, more power was surrendered to the market. This allowed for a number of smaller, more nimble enterprises to foster. Since the beginning of 1990 to the end of 2000, there were more than 1,400 initial public offerings in Japan. The domestic economic crisis also forced major corporations to undertake restructuring efforts of their organizations, operations, and finances. In Japanese, Risutora [restructuring] had become a form of survival, and in some cases, created legendary turnaround situations such as Nissan.

Has your investing process changed over the past 18 months in how you evaluate companies for your funds? Moving forward, will you change how you evaluate companies?

We have maintained our core investment philosophy and approach, which has proven its effectiveness in troubled times before. To elaborate, our investment philosophy is summed up in the phrase: “Macro is the aggregate of the micro.” This fundamentals-based approach emphasizes stock selection based on direct research. We view investments as the participation in the narrowing of the value gap between a company’s intrinsic value and its market price. We determine intrinsic value through an established and highly disciplined approach, which includes evaluating various factors such as market growth potential, management quality, balance sheet strength, and earnings quality.

Given the current market environment, we are particularly focused on certain aspects of our valuation metrics when we evaluate companies. One area of particular focus is balance sheet strength. But this approach goes beyond merely analyzing numbers, and includes understanding a company’s balance sheet and how it relates to their business. For example, take a company such as Keyence, which makes factory automation sensors. This company’s business model makes it possible to operate with limited capital investments in comparison to other companies with the same profit levels. In other words, because the company does not invest in plant facilities and a large part of its revenue gain turns into free cash flow, plenty of cumulative cash appears on its balance sheet.

The 1990s in Japan led to a long-term change in consumers’ attitudes toward risk and debt. In the U.S., savings rates have had a remarkable turnaround, and now many worry that it will be difficult to get consumers to change that attitude even if the banks begin to lend.

People who are more uncertain about the future tend to save more, so you may indeed see an increase in savings in the U.S. In Asia, the savings rate has historically been much higher than in the U.S. What truly hurt consumer demand in Japan in the 1990s was deflation, because decreasing prices give a strong incentive for consumers to delay purchasing decisions. Hopefully, the U.S. will learn from Japan and take all necessary steps to avoid a deflation scenario, and the U.S. government appears to have taken a number of fiscal and monetary actions to prevent that.

While consumer demand may contract in the U.S. as consumers save more, it looks to rise in most of Asia over the mid- and long term. While China, India, and other markets in Asia have experienced a slowdown in growth, they are still growing. Japanese companies should benefit from economic expansion in the world economies, particularly in Asia.

The consumer-oriented companies that are held by the SPARX Japan Fund are among those best positioned to benefit from rising demand in Asia. One such example is Kao, which makes a host of household products such as cosmetics that consumers both in Japan and abroad want. Although in terms of pure revenue generation the company still significantly lags global peers such as Procter & Gamble and Unilever, we believe that Japan’s household products have greater potential to successfully penetrate throughout Asia due to its high-quality product lines tailored to local preferences, including cosmetics and home care products.

The export-driven economies of smaller countries like Korea, Taiwan, and Singapore are feeling the recession deeply, with unemployment growing by leaps and bounds. What is your short-and longer term outlook for Asia in general and these export-driven nations in particular?

Generally, economies that are highly reliant on trade look set to suffer over the short-term. Trade credit is restricted and demand growth has declined. Looking further out, we are encouraged by the fiscal stimulus plans being enacted throughout Asia, particularly by China. Furthermore, Asia has several key advantages over the U.S. and Europe, the most important of which may be that it still has a functioning banking system. This means that the fiscal stimulus measures that are taken in Asia will likely be more effective, because banks will be more apt to extend credit and allow the fiscal stimulus to spread through the economies across Asia.

Our readers are entrepreneurs. Do you worry that the big government stimulus plans in the U.S. and Europe will squelch the entrepreneurial spirit and put a damper on more wealth creation?

I founded SPARX in 1989 as one of the first truly independent asset management companies in Asia, so I can relate to the desire among advisors in the U.S. to also be independent. As an entrepreneur, I also understand the desire to be able to operate your business free from government interference. At the same time, please do not forget the lessons that Japan in the 1990s taught us. There is an economic crisis in the world, particularly in the U.S. Strong policy measures, including fiscal stimulus, is going to be necessary to get us all out of this crisis. The Japanese government’s actions and lack thereof in the 1990s has taught us that it is better for governments to act quickly and decisively at the beginning of a crisis, or the pain will just drag on.


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