Danger & Opportunity: The Silver Lining

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.