The upside of Japan's corporate governance revolution

Fidelity's Jed Weiss believes momentum behind corporate governance reform in Japan could unlock considerable value for shareholders of Japanese stocks.

• A wave of governance-driven reform is sweeping through Japan, bringing with it a much tighter focus on shareholder-friendly practices and corporate responsibility, according to Fidelity Portfolio Manager Jed Weiss, who believes crucial changes in Japan's Corporate Governance Code will yield some promising investment opportunities.
• "Historically, Japanese corporate culture has not always prioritized alignment of management and shareholder interests as highly as in the U.S. or Europe, nor has it placed a lot of emphasis on board accountability and independence," explains Weiss, who manages Fidelity Advisor^® International Small Cap Opportunities Fund. "This has often led to suboptimal outcomes for investors, so recent changes to the contrary are most welcome."
• In helming the diversified international equity strategy since 2008, Weiss favors small- and mid-cap growth companies with multiyear structural growth prospects, high barriers to entry and an attractive valuation. In particular, he focuses on cyclically out-of-favor businesses with pricing power and limited competition, as well as firms exhibiting strong earnings potential and a share price that has fallen due to macroeconomic or other events.
• Weiss sees evidence of the corporate culture shift in Japan reshaping the investment landscape for smaller-cap equities, which suffered for about two decades from a prolonged bear market following the market's peak in 1990.
• As an example, he notes that some Japanese firms with limited histories of distributing surplus capital to shareholders have implemented significant stock-buyback programs, including THK, a leading mechanical engineering, robotics and automation company in the MSCI EAFE Small Cap Index. It plans to repurchase 20 million of its shares, representing roughly 16% of its issuance at time of the firm's announcement in late 2024.
• Weiss believes that recent reform has yielded a number of positive changes. Take Fujitec, a fund holding as of November 30 that has been closely managed by a founding family that owned a sizable stake in the company and had a history of making business decisions that weren't always in the best interests of most shareholders.
• "Then, in 2023, an activist investor successfully implemented changes to the firm's board composition, leading to significant improvement in its governance and capital allocation practices," contends Weiss. "The result? An improved balance sheet, a higher profit margin and a subsequent rally in the stock."
• Weiss points to another critical change stemming from updates to Japan's Corporate Governance Code: the unwinding of cross-shareholdings among numerous Japanese corporations.
• This reduction in the number of publicly traded companies holding shares in other publicly traded firms frees up cash for businesses to either buy back their own stock and/or pursue other shareholder-friendly activities, a potential game-changer, in his view.
• "Despite these promising developments, the fund has remained significantly underweight Japanese small- and mid-caps, although Japan represents the single-largest geographic exposure within the portfolio and its benchmark," Weiss says. "However, I am eager to capitalize on reform-driven investment opportunities as they arise."