Dan Buchanan: Welcome to the latest in our abrdn Closed End Fund podcast series. I'm Dan Buchanan with abrdn and today we are focusing on Japanese equities with the Head of Equities Japan Deputy Head of Equities Asia Pacific and portfolio manager of the abrdn Japan Equity Fund - ticker JEQ – Kwok Chern. Morning, Chern.

Chern: Morning

Dan: Or good evening in Singapore? Chern, let's start, can you give us a quick roundup of how the year has tracked so far for Japanese equities?

Chern: Okay, this year so far has been pretty positive. So as of 10 February, the Japanese market is up about five and a half percent. Okay. So, if you dig down into some of the details of what's going on, just like elsewhere, there has been a bit of a reversal from what's happened last year. So some of the cyclical stocks in Japan have rebounded, you know, whereas last year, some of these stocks were sold on pretty sharply okay. But, you know, but in January, we saw strong rebound although lately the rally has eased a little bit, okay.

The two other things that I think are a little bit different about Japan, coming into this year. Now, banks, which did well, last year, on the back of rising rates, you know, as a result of, you know, of inflation. Banks continue to do well in Japan. And that's on the view that the Bank of Japan will continue to tighten policy. This is based on rising inflationary pressures in Japan.

The other area that's done relatively well in Japan is stocks that are trading below price to book. And these stocks are typically deeper value type stocks. But, in the market - and I can elaborate on this in a minute - the Tokyo Stock Exchange has come out and mentioned, you know, the undervaluation of some of these stocks in the market. And they've been encouraging these companies to raise the ROE, so that the price to book ratio can be better improved, and to allow Japan to be a more attractive market. So it's on the back of that, this basket of stocks has done well, this year.

Dan: And where do you see opportunities today? You know, it's March 8th, looking forward into 2023 - if you can look into your crystal ball Chern, please. Where are you seeing opportunities out there, whether it's sector or different industries?

Chern: Sure, let me touch on a few areas where we find decent opportunities in Japan. So I think the first thing, when we're thinking about this year is a normalisation of conditions. And that's especially across Asia, especially for China as China is reopening. There are many aspects that will happen as a result of this right? Components that have been in short supply, because of the logistics, because of shutdowns in production in China and so on. These issues should ease this year as China reopens its economy, so normalisation conditions from China's reopening, you know, components should be in better supply, you know, some of the logistics issues that we saw over the last year or two should start to ease.

Business conditions in China will start to ease as well. And as again, you know, China reopens and as the government looks at normalising condition, right, getting the economy to rebound, or to at least start growing again.

One other point I would add with regards to the normalisation conditions is, what the Bank of Japan is doing. And if you follow the news in Japan, the market is expecting the Bank of Japan to start normalizing conditions through tightening its monetary policy. So at this point, the market is expecting things like negative interest rates to be abolished. And also, of course, you know, yield curve control that a bank of Japan has put in place since 2016, to be to be eased, right, so, so as a result of that, you know, conditions could tighten, but that's also positive for some areas that market in particular banks.

One more area that I think is quite interesting, are on the idiosyncratic factors that you see that, perhaps, is a result of, you know, a bottom up stock picking. One area that we find interesting is with pharmaceutical companies, they have, of course, you know, you look at the pipelines and, there's some events that were happening this year, some data readouts, and we remain pretty positive in that area.

Other idiosyncratic factors another one I’ll highlight this again, you know, the point I made early on low price to book type stocks, right. These are, again, you know, the Tokyo Stock Exchange has come out and encouraged companies trading below book to raise the valuations by either returning capital shareholders or just being more shareholder friendly. Right. And typically, in this area of the market, you know, some stocks do deserve to trade below book, because there might be some issues to the business and so on. But others, you know, for cyclical reasons, are trading below book, and that we find is a more interesting opportunity. Right, so, so again, there are some idiosyncratic factors that that we can find in Japan, that’s quite interesting, alongside, you know, sort of normalising of conditions, whether it's from China's reopening or what's happening at the BoJ, you know, monetary policy in Japan, you know, we think, these opportunities that are available in Japan at this point.

Dan: Thank you, Chern, for those comments. Let me switch gears for a moment and talk about some of the considerations that an active manager today maybe at abrdn might look at, particularly around environmental, social and corporate governance, also known as ESG. And I'm curious with the Japan equity fund JEQ. How is the fund position on this aspect?

Chern: Thanks for asking that question. ESG is one of the most important aspects, you know, when it comes down to our analysis of companies. Right? And essentially, it just suggests that companies, should be aware of how they're treating all stakeholders, instead of just a narrow group of stakeholders, right? So in the sense of, ES in Japan – that’s a little bit more straightforward. When we assess companies in Japan, the ENS companies tend to do pretty well on the environmental and social front. At many times, for us, it's encouraging companies to disclose what they do, because they actually do a quite a lot of good things, positive things, but they don't tell investors or the public about what they do.

On the governance front, here, we see a few additional challenges here in Japan. Now, if you've followed Japan for a period of time, you know, that, you know, governance in the past has been an issue in Japan, and it has been improving, but we think that there's still more that can be done.

So, in governance, in many times, for Japanese companies, it's just - they need to improve and get the standards alongside some of the developed market peers, right. So, things like you know, more independent directors, awareness of shareholder returns, you know, winding cross share holdings, these are important points that we discuss with companies and what we'd like to see as you know, that these, these issues improve over time for companies, we don't expect fireworks, you know, that things will change dramatically overnight, but we expect companies to work at these areas to improve over time. So ESG, you’re right Dan, is very, very key, to our process to assessment of companies in Japan.

Dan: Those are great points around governance. Appreciate that. Let me switch gears one more time on you Chern. JEQ is a closed end fund, as a structure, as an investment vehicle. I'm curious from folio managers perspective, how does the closed end fund vehicle help you to effectively manage a portfolio like Japanese equities?

Chern: Okay, if you look at Japan, you actually have a pretty deep market, and you have something like 3500 listed companies or more. And, and you can find all sorts of companies in Japan, which allows you to capture you know, get the exposure to different parts of, you know, many different parts of the market, many different parts of the world, many niche areas, etc. Right. So, and one of the, one of the benefits of having a closed end fund, it allows us to invest across the market, from smaller companies to larger companies. And with the closed end fund structure, then you can properly construct your portfolio, according to where you find opportunities, right, whether it's smaller companies, larger companies, etc, right?

Another the benefit of a closed end fund is gearing. Now gearing has its upsides and downsides. But when we see, when the market valuations are favourable, you know, for us for shareholders, right, gearing allows us to enhance returns. Right, so, so these two facts, I think, quite important when it comes to running a closed end fund, and we use both, we believe we use both to our advantage.

Dan: And gearing also known as leverage, I would say one other benefit, obviously, from your perspective, I would imagine would be the ability to avoid cash drag, meaning, you know, new money coming into the fund, maybe at peak heights of valuations going to work, and conversely, redemptions on the other side. So, helps you to stay long term for that. Appreciate that. And finally, Chern, how are you seeing the rest of the year shaping up? We talked about this a little before. But I'm just curious for investors and potential investors out there, why should they be looking at adding Japanese equities to a portfolio today?

Chern: Okay, for Japan, I would say that there are a few things that are specific to Japan that's quite interesting. Now, before we get into that, just the back up a little bit. Of course, there are risks, you know, in investing in equities across the world, and we know what the risks are, you know, the persistency of inflation, this can be a headwind. You see continued geopolitical tension, you know, and that affects, of course, the Japanese equity markets as well. Right. The flip side to this is, you know, some of the, of course, some of the idiosyncratic factors that I mentioned earlier, and the fact that you have this, the depth of the market allows you to capture some of these opportunities that we can find in Japan. And plus the closed end fund structure allows you, it allows us to, to go where the opportunities are, right.

But more specifically, if you look at this year, we would expect some of the headwinds from last year, to start to ease, right, the companies that have been battered in the last year, you know, should shape up a lot better. Commodity prices, we can argue, you know, where it's going, whether it's up or down, but you know, we expect that to to at least to moderate from here, likewise, rates should moderate from here. So while inflation remains high, we believe that, you know, conditions should be moderating. And that what this then means is, so the good quality companies in Japan, the ones that are, that have had to fight back on, on higher input costs, you know, weaker profitability, should start to reverse that. Right. And there'll be an inflection point, we believe, this year, and margins just start to pick up again and profitability should start to improve. This is of course, for companies that have, that have some pricing power that are very strong brands, that have very strong market shares, you know, in the area they’re operating.

So, we believe that these businesses which redeem good quality business, should start to do well, again, and alongside that, you know, normalising of conditions, as well as some, some particular, you know, areas within the market that we find interesting should help the market do a lot better this year than last year.

Dan: And probably not to mention Japan is the third largest economy in the globe, I believe, as of last year, a very well-educated workforce. And that's certainly a spur in that, that GDP. We thank you so much Chern for your insights today. And thank you particularly to our listeners for tuning in.

You can find out more about the fund, the Aberdeen Japan Equity fund - ticker JEQ – at www.abrdjeq.com. I'm Dan Buchanan with abrdn do look out for future episodes.

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