EPISODE 7

Transcript

Gene Reilly [00:00:00]  

Hello, I'm Gene Reilly, the Chief Investment Officer of Greenwich Quantitative Research. We use quantitative techniques to invest in long and short equities in the Asia Pacific region. I'm delighted to be joined by my former colleague at Goldman Sachs in Tokyo, Kathy Matsui. Kathy is a general partner of MPower Partners, Japan's first ESG venture fund.

Run by women. 40 percent of the portfolio is also invested in businesses run by women. Kathy was for a very long time, the chief Japan strategist for Goldman Sachs, as well as the vice chair of Goldman Sachs, Japan. Kathy was credited by former Japanese prime minister Abe for coining the term ‘womenomics’ in 1999.

Kathy was also the number one Institutional Investor, Japanese equity strategist for many years. Kathy, it's great to be speaking to you. And it brings back great memories of when we were working together in Japan. Tell us more about MPower Partners. 

Kathy Matsui [00:00:50]

Sure. And great to be here with you, Gene. So MPower Partners was founded by my two girlfriends and myself in May of 2021.

And the hypothesis that underlies the fund is we felt that for Japan to have a more vibrant startup ecosystem, it really needed a couple of things. One was a greater focus on factors that frankly make any business thrive, make it grow, make it scale, whether it's robust governance practices, being mindful about diversity within your leadership, having some sense of what impact your business was having on the climate we thought was, very, very like a given.

And so we thought that instilling these principles when a company is in its infancy, evolutionary phase, as opposed to when it's large and established was easier to get traction injecting these principles into the company's startups DNA from a very early stage would help those companies scale and grow faster.

And so that was the hypothesis. We wanted to form this fund to prove this hypothesis, and we were very lucky in 2021 to get the backing of major Japanese financial institutions, corporations, overseas family offices, and we launched with 150 million US dollars. It's an offshore Cayman registered fund.

We invest two thirds in Japan startups and one third outside of Japan. Currently we have 19 companies in our portfolio and it's been a terrific journey. Just learning about companies in many different domains. And again, we're ESG integrated, which means that we not only invest in ESG related areas like climate tech and sustainability, but they're not all in those domains.

We have companies outside those domains. But the important line for all of our companies is that they commit to instilling or integrating ESG considerations into their core businesses. We of course help them and support them on this journey, but we've been having terrific experiences with all of our founders both in Japan and outside Japan, and we're eager to continue.

Gene Reilly [00:03:19]

Well, Kathy, congratulations. That sounds both a huge accomplishment and also very exciting. Are there any investments that MPower has made that, that you could tell us about? 

Kathy Matsui [00:03:29]

Sure. We've made some really very interesting investments. I'll tell you one that we made here in Japan and it's called Heralbony, H E R A L B O N Y.

It's very hard to pronounce even in Japanese, but it is a digital IP platform for artists with disabilities. And this company was founded by twin brothers, whose eldest brother has severe autism. And they discovered in many of these institutions around Japan, where disabled people live, that there's some amazing artists and they're producing amazing work, yet that work is not seeing the light of day.

So what they do is they take the work, the best of the best of this artwork, and they essentially license it out to enterprises like Japan Airlines or JR East, the big railway company, or Hyatt Hotels. Most recently they are tied up with Louis Vuitton Group, and essentially what they're doing is monetizing the value of this artwork that is created by these artists.

And I just mentioned Louis Vuitton. So this company has just launched an office in Paris and they want to become the digital IP platform for disabled artists, not just in Europe. They eventually want to go to the States, and expand in the rest of Asia as well. And you think that this is just like a social impact kind of business, you know, really impactful, but doesn't make a lot of money.

It's quite the opposite. This company has seen revenues double, double, and double again this year. And it's really on a tear and getting a tremendous amount of positive reception. They're winning every pitch contest. So we're super excited to back this company as the largest shareholder of this company today.

So it's companies like this where we can really get excited about the company and building fans to support the company, introducing the company to big enterprise customers potentially, and of course, overseas entry or market entry into overseas markets. That's where we think we have strengths given our team's nature.

These are the kinds of companies that we really get excited about. 

Gene Reilly [00:05:34]

Well, Kathy, that's amazing. It sounds like a fascinating idea. It's doing a lot of good and it's making money. So congratulations. That's a great company to have in your portfolio. So there's a lot to talk about today. The Japanese equity market, as you know, has had an incredible rally over the past 12 years.

We're also driven by a focus on corporate governance, but also the monetary environment has been favorable. Then this year has been very volatile. Inflation emerged and the historic zero interest rate policy is coming to an end. In August, the Nikkei 225 sold off by 19%, which is huge, and then largely recovered.

In September, Shiba became a surprise choice for Prime Minister, then called a snap election, and largely lost. So the future doesn't seem as clear as it was a few months ago. So Kathy, let's start at the beginning and discuss the corporate governance reforms and the ensuing equity rally.

The Nikkei 225 is up almost 4x since the beginning of 2013. Corporate governance reform is the most cited reason for the rally. So when did the change really start to take hold in Japan and when did investors start to believe it was real? 

Kathy Matsui [00:06:36]

So, I think this goes back to, frankly, the beginning of former Prime Minister Abe's second term in office, which started the end of 2012, beginning of 2013.

And quite quickly out of the gate, Prime Minister Abe focused on this issue of corporate governance. So, you kind of think, why would a national government focus on corporate governance? Corporate governance as a national strategic topic. And I think it's quite simple because as you know, Gene, very well, one of the biggest issues, of course, about Japan is the fact that it has a humongous amount of fiscal debt, right?

And a shrinking population. It's the worst possible combination. And so for the sake of fiscal stability, there needs to be better returns on assets. Meanwhile, The household sector is sitting on some 2,000 trillion plus yen of cash, which for the most part is sitting under the futon or in the banks, getting zero interest rates, right? Zero return. 

And so the idea is how to unleash this sort of sleeping cash, this firepower into the economy. And one mechanism of doing that, of course, is for example, the stock market, through financial assets. However, If you look at Mrs. Watanabe, I'll call her, the retail investors participation in the Japanese stock market, it used to be quite high, but over time it, it, it steadily declined.

And why was that? I would argue it's largely because Mrs. Watanabe is not stupid. She looks at the risk return profile of Japanese equities historically and said, this is not attractive. The risk is too high for the potential return. And of course, the market had been on a long term slide downward, basically since 1990.

So it made no sense for her to park her money into a Japanese equity. The other thing I think that would have made her change her mind perhaps was, for example, if there was a higher dividend yield on Japanese stocks, but the dividend yield historically has been super low despite the maturity and the level of low growth that Japan's economy overall has.

So there wasn't anything very attractive. So I think the government finally woke up and realized if we don't force the biggest companies of Japan that's that are moving the economy to pay greater heed to the interests of shareholders, and particularly those of minority shareholders, that nothing's going to change in this regard.

And so, hence, that's what kicked off the institution of various codes of behavior like the stewardship code for asset managers that basically said you have a fiduciary responsibility to act on behalf of your investors. Number two quickly followed by the institution of a corporate governance code.

Now think about it, India had a corporate governance code before Japan did. It was very late in coming, but finally you have this code where companies, i. e. the issuing companies of stock had to take a hard look at how are their assets being managed? A lot of them have lazy balance sheets, right?

I mean, we have a lot of cash on balance sheet, not doing much with the cash, not giving dividends to shareholders, not paying their workers, not investing. So what the heck are they doing with their cash? Essentially sitting on it right now. Of course, it was deflation. So economically speaking that stance may have made some sense.

But the bigger picture thing is, I think the government finally said we need to have greater discipline in the way that publicly traded companies are managing their balance sheets and are managing their businesses. And before I think when we were working together in Tokyo for many years, Japanese companies, for example, never had outside directors on their boards.

A lot of our Japanese institutional clients never actually voted proactively in shareholders meetings. So it was a very different standard of corporate governance in Japan. And so this institution of these various codes lifted the standard of corporate governance not exactly to global standards, but much closer to that. So I think that was really the ball that started rolling. And I think people realized during this period.

Remember, even prior to this, there were a lot of activist investors, right? Whether it's Murakami fund or Steel Partners, they're looking at companies trading at well below book value and saying, oh, this is ridiculous. They're swimming in cash or they have all these property assets, they shouldn't be trading on the stock market.

So there's a lot of pressure from a few shareholders, loud shareholders, but that in and of itself, wasn't really getting much traction. So it's really the government saying top down, this is the way it's going to be. And you've got to get with the program. And I think this really, really began to change not only the behavior of companies, but also of investors, which was very, very important.

I think again, we're still a work in progress. There's still a lot more work to do, but I think now finally the ship is sailing in the right direction. And this, recovery, as you said, in the stock market is a reflection to me of many of these structural changes that finally Japan is getting with the program, moving towards global standards and governance.

It doesn't mean that every company has got religion by no means, but those that do are clearly seeing that reflected in a higher market value than ever before. So I think it's very healthy the direction that we're finally heading in, but it took a long time. 

Gene Reilly [00:12:20]

Sure. And that's a great segue to my next question.

And you're, I'm just remembering, you're absolutely right. It wasn't easy to be an activist investor in the Japanese equity market for a long time. And it does seem like that's changing. You were mentioning some of the things that are still on the table going forward that can be, that can be done.

What do you think the next major targets can be to continue the corporate governance reform that are going to have significant impact on valuation? 

Kathy Matsui [00:12:50]

Well, I think there are various movements in place, including you now have the stock exchange really focused on this phenomenon of many Japanese companies trading well below their book values.

And that is a phenomenon that's pretty unique to Japan. And that's why you have every major activist fund in the world looking at Japan with very eager eyes because it looks so attractive. But that is now putting a lot of pressure on these companies to address why is their book value so low or their price to book ratio is so low.

It's also forcing companies, for example. There are now regulations regarding board diversity. You have to have not only independent directors that are truly independent, it doesn't count if you have somebody from your subsidiary company on your board, that's still a relationship, right? It has to be truly independent.

You also now have, shockingly for this country, a requirement that you have to have at least one female on your board. And so my friend runs a business that basically does board placement for female directors here. And she said something like, we have over 2,400 seats to fill. This is just one for one female in each board.

So we've gone a long way, but we still have a long way to go to identify females who could fill these board seats. So slowly, but surely, I think the pressures are gradually building. And I think you may have heard, this is public, but the company Canon experienced something called the Canon shock a couple of years ago.

Why? Because they didn't have any female directors on their board, a very successful global company and investors in Canon had in their voting guidelines if a Japanese company has zero female directors, that triggers an automatic no vote against the CEO. So the CEO of Cannon saw his approval rate from the AGM go from over 90 percent to 50 something percent, so just collapsed, right?

And that's super embarrassing in this country. So slowly but surely I think this combination of sort of rules, as well as I call it shame and embarrassment, is also very effective in Japan in motivating people to change. It's this whole combination of things that I think is finally, even for the most stubborn of companies, you have seen dramatic shifts occur.

And again, I'm not saying that everybody's got religion by no means, but at least we're seeing a lot more action being taken, also dividends and share buybacks. That was never a thing in Japan. And now not only activists, but normal shareholders are asking, what are you doing with all this cash? What are you doing with this retained earnings mountain that you have?

Gene Reilly [00:15:43]

Right. That's a great point. And the Tokyo stock exchange seems to be following up. I noticed in January, 2023, they mandated that companies that had price to book ratio below one had to issue a plan to address how they're going to change it. So it looks like this is really meaningful and I think It explains a lot of the rally but you know It's a good segue into the other thing I wanted to talk about and that is since the pandemic the yen is also weakened considerably.

It touched a low of 160 yen to the dollar, which is amazing I couldn't have believed that level when I was actually living in Japan when it actually seemed very expensive. But Japanese companies have become much more competitive at these yen levels. It certainly added fuel to this equity rally. So the question would be, how could you parse the effects of the corporate governance reform, which was the first part of this rally, and then the yen competitiveness and the yen price added additional rocket fuel to the rally over the last few years.

How would you parse the effects of corporate governance versus monetary policies explaining what's been happening in equity prices? 

Kathy Matsui [00:16:49]

Well, I don't have any scientific way to answer that question, Gene, but I think that from my personal vantage point, since I was working at Goldman, still in the stock market, when the changes I just described were beginning to take root. It was 13, 14, 15 the government also all of a sudden latched onto this topic. I'd written about a quarter of a century ago unbelievably about ‘womenomics’. That I think this sort of idea or sense that after so many changes in government. 

Remember Japan used to have a new prime minister every 10 months. Remember when we were working together, it was like a a turnstile. 

Gene Reilly [00:17:30]

We might be back to that. 

Kathy Matsui [00:17:32]

Could be, but I think the issue is that there was finally, at that time, political stability, which allowed for the government to tackle some deeply rooted structural reforms which are very difficult to tackle if you only have three months to go or six months to go in your term.

And so I think that was really the core catalyst to allow the the market to at least bottom and to start to recover back then. Of course, I think the yen, as you said, is like a tailwind, but I doubt that the yen alone, because we've had yen weakness episodes, as you know, many times in the past 30 years plus, and yes, it leads to a bit of a temporary lift in the stock market.

But it alone does not allow for a prolonged bull market to occur. So I think it's maybe a combination of the two, but I would put more weight actually on the structural changes as opposed to just the the currency weakness, right? 

Gene Reilly [00:18:36]

Right. Very interesting. And then now we're saying we're at a turning point, both politically and from a monetary policy perspective.

In March, the Bank of Japan finally exited the negative interest rate policy after a long time. They lifted the rate tariff target to 20 basis points to get it to positive 10 basis points. Inflation has continued to be stubborn. The yen continued to weaken. And then in July had hiked again by 15 basis points to only 25 basis points.

But the market declared the end of the yen carry trade, the Nikkei sold off 19%. It was actually a very big event in Japan. Then subsequently recovered. I’m curious whether you think the Bank of Japan is done yet? Or will inflation and angry consumers push them to do more? And will this be the tipping point for, for what's been an amazing equity rally?

Kathy Matsui [00:19:30]

Well, I don't frankly know the answer to that question either. But what my sense is that this extraordinary period of zero interest rates, which Japan frankly started, the world trend in ZERP, so to speak, zero interest rate policy was so extreme and so prolonged largely because Japan was one of the few countries that was actually in outright deflation, not disinflation, but deflation.

And I think so coming out of deflation, you're right, we do have now actual inflation, not only of consumer prices, but finally, that's being followed by wage inflation, which is frankly a long time in coming. So I think that the Central Bank is trying to normalize its monetary stance to reflect the new monetary conditions that it's now facing.

But having said that, I think the Bank of Japan is being very mindful of not overdoing it both in speed and magnitude. And I think at the end of the day, they want to see inflation overall. Including wages remaining high, you know, or steadily high enough that they feel that they can make, another move or subsequent moves in in rates.

So I think this is the right position or the right stance. And I think it's also why the yen remains weak because people believe this, that the Bank of Japan is not going to make any abrupt decisions for fear of repeating the same mistakes of the past. So I'm not too concerned of them over tightening too quickly.

And if you think about it, I mentioned earlier that there is so much excess savings in the household sector, people think interest rates going up is a terrible thing. Well, not for a domestic economy where the household sector is swimming in cash, right? 

Gene Reilly [00:21:41]

No, of course not. 

Kathy Matsui [00:21:42]

They, they want to have something that they can earn at the bank, right?

So it's not all negative. And so I think that that's probably that balance trying to find the right balance between the two interests. I would call it it's going to be a very careful, careful line to tread. But I'm not, as I said, not too concerned about them going overboard. I think there's plenty of pressure on them.

And of course, not, not to mention the fiscal deficit is still very, very large. And if they push too hard, that that could mean some fiscal instability, which is the last thing the government and the economy needs right now. 

Gene Reilly [00:22:17]

No, I totally agree with you. And I think also the fact that the Shiba now has a, very tenuous coalition probably leads to reinforcing the status quo, to your earlier point on how frequently Japanese prime ministers used to turn over. Changing tack slightly, let's talk about what's going on in China, which is really interesting.

And another market that we're involved in. The People's Bank of China announced in September that they were implementing a major stimulus plan, which was a which was USD 1 trillion and approximately 6 percent of their GDP. They're deploying both monetary and fiscal policy to address the real estate crisis and the stock market.

They will also recapitalize banks, they'll bail out highly indebted local governments. Obviously this will have a spillover and should be really positive for Japan, but wanted to get your take on how significant the impact of this would be on the Japanese economy and markets. And, and is it something that people in Japan are talking about?

Kathy Matsui [00:23:12]

I think that you have to take a step back and realize that Japan is as dependent on China as it is on the United States, right? These are the two largest trading partners for Japan. And so, if China catches a cold or pneumonia, that's terrible pretty much for Japan. I'm talking aside from all the geopolitics, right, the reality at the economic level is very different.

And so, whatever China can do to bolster growth, to reform the economy, in a healthy way has helped us. It's pretty unambiguously positive for Japan and I think this is a little bit of a tangent, but the tensions between the US. and China, at least geopolitically, and talk of tariffs and all of that.

It's tough for Japan because on the one hand they're dependent on the United States for the so called security umbrella that the US provides for Japan. On the other hand, as I said, Japan is super dependent on China, in economic terms. So can Japan just say, you know, whatever the US says on China goes or is okay with us? They can't say that, right? So it has a much more nuanced stance. If you're here in Japan, and especially if you talk to people in the private sector about China, it's a very different tone than when you hear at the governmental level. And so I think because of that, like I said, if China, fails to support its economy or fails to enact these structural reforms, that is not, unfortunately, good news for Japan.

So they're watching, of course, China's course from here very, very, very, very closely. 

Gene Reilly [00:25:12]

Well, that's a fascinating perspective there. Everything really gets run through the prism of US / China, but it's great to look at it from another perspective as well. While we're talking about geopolitical risk it's high in other regions as well.

The situation in the Middle East could escalate and lead to really minor or even major disruption of oil supply from the Gulf. Japan is the world's fifth largest energy consumer. It imports 90 percent of its energy needs. That's significant. Do you think with where the Nikkei is now that that this potential geopolitical tail risk is priced in?

Are people paying attention to it? 

Kathy Matsui [00:25:52]

I think people are definitely paying attention to what's going on in that part of the world, but, and again, I'm not looking at this market closely. But what I've read in the headlines, at least, it feels like the supply is pretty plentiful despite all the chaos going on in terms of Gaza, et cetera.

And so if that changes and there's a significant disruption to supply or supply routes, et cetera, that of course would be a significant problem for Japan. So I think Japanese are watching very closely this whole region at large and paying close attention to the developments, particularly related to the war happening there.

But until this is reflected in different supply demand considerations and pricing, I don't think it's a topic that's everybody is talking about. I think right now the topic, top of mind is the U. S. elections more than anything else. But of course, as you rightfully point out, the dependence on Middle East for Japan's energy needs is huge.

And that's also why the government here has really been trying to put extra efforts into developing alternative renewable sources of energy. It's still not where it needs to be by any means, but they're definitely investing a lot in the GX or the green transformation of this country. 

Gene Reilly [00:27:25]

That makes sense.

You know, I was at a dinner with Nouriel Roubini, who is always good for a doomsday scenario. His concern was not a high probability event, but if Iran and Saudi Arabia somehow got drawn into the conflict and it led to attacks on oil fields that could lead to a major, major supply shock that he thought might not have been priced in.

And he did make the observation that both China and Japan are probably more likely to be affected by that than the US given where the U. S. is right now. And you mentioned the US election. That's tomorrow. We might know the results  tomorrow, we might not. It's going to be interesting.

But Kathy, I wanted to thank you. This was wonderful This has been a fascinating discussion coming at a very relevant time for Japan and the rest of the Asia Pacific. Thanks for making the time, it's been a pleasure. It's been very interesting. Let's, let's do this every year 

Kathy Matsui [00:28:24]

Great talking to you.

Gene Reilly [00:28:25]

Great. Thanks so much. 

Kathy Matsui [00:28:26]

Thank you

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