China’s technology sector, once a discretionary purchase within a regional portfolio, now deserves scrutiny. (more…)

In an endemically low growth world, prone to accelerating forces of disruption, (more…)

Those who have seen our opinions on Japan will know that our arguments on expanding equity returns in the country are predicated on the condition that Japanese corporates implement reforms, aimed at increasing shareholder value.

We like to think of long term investment as being evidential, and are therefore seekers of proof for our beliefs.

We have already seen a string of positive developments. Most recently, Fanuc, a large cap Japanese robotics manufacturing business, has announced the hiring of an investor relations team. The company was previously known for purposefully avoiding shareholder contact. This is a significant development, with a 1.2% weight in the TOPIX index, Fanuc is leading by example. Other noteworthy changes include the reduction in cross shareholdings between companies, announcement of dividend increases and share buybacks.

With the prominent launch of the JPX Nikkei 400 Index, one particular measure of shareholder value creation has been pushed into Japanese CEO’s spotlight – return on equity (‘ROE’). The index gives it a 40% weight in its selection criteria, besides operating profits (40%) and market capitalisation (20%), in arriving at its 400 constituents.

ROE can be decomposed into three measures, according to an analysis first introduced by the DuPont Corporation in the 1920s. ‘Net Profit Margin’ multiplied by a company’s ‘Asset Turnover’ and finally multiplied by the ‘Leverage’ employed equals a company’s ROE. The below table defines these ratios further.

ROE factors

We have examined the three factors for the Japanese market, using the TOPIX index as proxy to assess where Japan is lagging the competition, i.e. other developed nations. In particular, we made a comparison to the S&P500.

We found a general decreasing trend in the ‘Asset Turnover Ratio’, which measures how efficiently corporates are employing their assets. This seems to have, however stabilised for the US, but is still declining in Japan. All in all, it is quite similar for both regions.

Topix - March 2015

Source: Bloomberg

Unexpectedly, leverage has been trending downwards, but is, at the moment, above the S&P 500 as US corporates have deleveraged even more significantly since 2008. Compared to Europe, however, both figures are currently at very low levels.

These two aggregate figures, of course, have to be considered in the context of the respective sector compositions underlying these indices.

The last measure, ‘Net Profit Margin’, is considerably lower for Japan. It has been so in a consistent fashion since the early 1990s, when our datasets start. This stark difference is resulting in the drag of Japanese ROEs versus the comparator countries’ corporates’ ROEs, even accounting for different sector compositions.

We believe that the greatest boost to ROEs will come from margin improvements and also from putting assets to use in a more efficient manner.

Asset turnover can be improved by shedding assets: for example, the vast amount of excess cash on balance sheets, accumulated as a result of corporates’ attempt to de-lever and to repair their balance sheets. Cash of that extent is dead weight, contributing little to profitability. Share buybacks and the increase of pay-out ratios are one example, how this can be achieved. Both are gaining popularity as course of action in Japan.

Also, the sale of non-performing legacy business units will improve the asset mix and enhance the turnover ratio as well as operating profit margins. This comes down to companies adopting more long term strategic goals, cutting unnecessary costs and therefore improving corporate profitability and ultimately shareholder value.

Another component of net profit margin that we expect to improve, besides operating profit margin, is corporates’ tax burden. The official corporate tax in Japan was over 35% at the end of 2014, compared to the official figure of 40% in the US. However, the actual figure paid by US corporates is much lower than that, whereas Japanese corporates have been paying an even higher rate than the 35%. At the end of 2014, the Japanese government agreed on a series of corporate tax cuts aimed at reducing the ultimate actual rate paid to below 30% over the next years. This will lift the tax burden and is a positive development for Japanese net profit margins.

The Japanese workforce remains highly inflexible. However, the number of part time workers is increasing and also the demographically induced structural decline of the workforce will help to reduce inefficiencies and streamline costs.

The reduction in taxes and the decline in the workforce should more than offset potential wage rises.

The last paragraphs have demonstrated that there is much room for improvement in margins and asset efficiency of Japanese corporates. We remain highly constructive and currently hold a 21.2% equity allocation to Japan in our TM Cerno Select fund, invested via one active manager and ETFs.

Last year, the Japanese Government Pension Investment Fund (GPIF) announced its intention (more…)

As ever, Apple’s product launches are greatly anticipated and 9th September was no exception. At that launch the iPhone 6, iPhone 6 Plus, Apple Watch, and an intriguing new payment platform, Apple Pay were revealed to the world.

Thanks to its tightly integrated iOS ecosystem, Apple’s hardware tends to feel less commodity-like compared to its peers and, as a consequence of Apple’s integration in users’ lives, the explicit and implicit costs of switching mount.

Its iPhones, iPads, iMacs, and the newest addition to the family, the Apple Watch, complement each other well by synchronising everything from apps to media (music, films and TV shows) to personal data (contacts, calendars, photos, etc.) through its iCloud and iTunes platforms. Apple’s ever growing application universe is a clear money-spinner.

Given the typically short product replacement cycle of 2-4 years for personal electronics, building a loyal customer base is thereby essential to the success of the business over the long-term in this maturing and highly competitive market.

It is generally thought that this loyalty lies on the sleek design, interface, simplification and sheer “wow” of their products. However, whilst the techies will froth on the screen size and resolution, the more meaningful business development is Apple’s grip on users’ lives. FT’s Lex column harpooned this fact in their column of 5th September stating that “most of those who shell out for the next iPhone will not be buying a phone, they are paying a toll”.

This is a toll to a near private garden. The iOS system is relatively simple when operated from within. However, access from a different operating system (say Android) can often be fraught with difficulty. Much of the data, especially licensed media, is either non-transferable or give people a very hard time when they try. For Apple users, hardware upgrades is as much a means to maintain access to the system as enjoying increasingly smaller benefits in feature specifications.

If confirmation were sought of this, it has arrived in the form of Apple Pay. Apple Pay utilises NFC (near-field communication) technology to enable contactless credit card payments in physical stores and allows ‘one-click’ online purchases (no card details to fill in) via the new iPhone and the Watch. While it may not contribute materially to near-term revenues, it offers a potentially valuable service that will further cement customers to the iOS system, if proved successful. Once the phone or the watch becomes your wallet, it will become more challenging to persuade users to depart.

In a stroke, Apple Pay is poised to take advantage of US$12 billion of daily transactions value in the US. Already, it gained strong financial institution and retail endorsements with negotiations held in typical Apple secrecy. Early backers include eleven of the biggest US card issuers including Visa, Mastercard, American Express and several major banks, collectively representing 83% of the market. Retailers such as McDonald’s and Walgreens are also on board. Further, they will be paying Apple 15 cents for every US$100 purchase for this privilege, an impressive feat of Apple’s bargaining power in persuading the key players in the payment industry to give up a slice of their revenue, something neither Google Wallet nor CurrentC (developed by MCX – Merchant Current Exchange) has managed to achieve.

As mobile devices handles increasingly sensitive personal information such as health/fitness records and payment details, data privacy and security is paramount to the integrity of the business, especially in light of the recent iCloud hacking debacle. In attempt to address these concerns, credit card details will not be stored nor shared on the device or in Apple’s servers. Instead, a transaction is authorised via one-time payment numbers, dynamic security codes, touch ID, and Apple forfeits a potentially lucrative opportunity to monetise user data by not tracking user purchases.

Whilst the technology is nothing new, Apple has timed its launch well. A major change set to occur in the payment landscape will require the majority of some nine million merchants to deploy new hardware in their stores within the next year, in compliance with the EMV (Europay, MasterCard & Visa) standard, and to reduce fraud levels rampant in the traditional magnetic strip system. Banks have made concerted efforts to push merchants to upgrade their POS (point of sale) systems to the ‘Chip & Pin’, widespread in Europe but virtually non-existent in the US (which still uses the traditional system). From 2015 onwards, issuers like Visa and MasterCard will no longer cover the cost of credit card fraud for retailers still on the old system. The new terminals should allow both PIN and NFC transactions, and streamlining of the online payment could also help speed up the uptake of Apple Pay.

iTunes revolutionised the music industry back in the mid-2000s. For the time being, card issuers and merchants believe that Apple Pay is a benign partner, forecasting an increase in transaction volumes to offset the fees they surrender to Apple. The transition process will take time, it remains to be seen whether this system, with its 800 million credit cards already on file (via iTunes Store), will disrupt to the payment industry on a similar scale.As ever, Apple’s product launches are greatly anticipated and 9th September was no exception. At that launch the iPhone 6, iPhone 6 Plus, Apple Watch, and an intriguing new payment platform, Apple Pay were revealed to the world.

Thanks to its tightly integrated iOS ecosystem, Apple’s hardware tends to feel less commodity-like compared to its peers and, as a consequence of Apple’s integration in users’ lives, the explicit and implicit costs of switching mount.

Its iPhones, iPads, iMacs, and the newest addition to the family, the Apple Watch, complement each other well by synchronising everything from apps to media (music, films and TV shows) to personal data (contacts, calendars, photos, etc.) through its iCloud and iTunes platforms. Apple’s ever growing application universe is a clear money-spinner.

Given the typically short product replacement cycle of 2-4 years for personal electronics, building a loyal customer base is thereby essential to the success of the business over the long-term in this maturing and highly competitive market.

It is generally thought that this loyalty lies on the sleek design, interface, simplification and sheer “wow” of their products. However, whilst the techies will froth on the screen size and resolution, the more meaningful business development is Apple’s grip on users’ lives. FT’s Lex column harpooned this fact in their column of 5th September stating that “most of those who shell out for the next iPhone will not be buying a phone, they are paying a toll”.

This is a toll to a near private garden. The iOS system is relatively simple when operated from within. However, access from a different operating system (say Android) can often be fraught with difficulty. Much of the data, especially licensed media, is either non-transferable or give people a very hard time when they try. For Apple users, hardware upgrades is as much a means to maintain access to the system as enjoying increasingly smaller benefits in feature specifications.

If confirmation were sought of this, it has arrived in the form of Apple Pay. Apple Pay utilises NFC (near-field communication) technology to enable contactless credit card payments in physical stores and allows ‘one-click’ online purchases (no card details to fill in) via the new iPhone and the Watch. While it may not contribute materially to near-term revenues, it offers a potentially valuable service that will further cement customers to the iOS system, if proved successful. Once the phone or the watch becomes your wallet, it will become more challenging to persuade users to depart.

In a stroke, Apple Pay is poised to take advantage of US$12 billion of daily transactions value in the US. Already, it gained strong financial institution and retail endorsements with negotiations held in typical Apple secrecy. Early backers include eleven of the biggest US card issuers including Visa, Mastercard, American Express and several major banks, collectively representing 83% of the market. Retailers such as McDonald’s and Walgreens are also on board. Further, they will be paying Apple 15 cents for every US$100 purchase for this privilege, an impressive feat of Apple’s bargaining power in persuading the key players in the payment industry to give up a slice of their revenue, something neither Google Wallet nor CurrentC (developed by MCX – Merchant Current Exchange) has managed to achieve.

As mobile devices handles increasingly sensitive personal information such as health/fitness records and payment details, data privacy and security is paramount to the integrity of the business, especially in light of the recent iCloud hacking debacle. In attempt to address these concerns, credit card details will not be stored nor shared on the device or in Apple’s servers. Instead, a transaction is authorised via one-time payment numbers, dynamic security codes, touch ID, and Apple forfeits a potentially lucrative opportunity to monetise user data by not tracking user purchases.

Whilst the technology is nothing new, Apple has timed its launch well. A major change set to occur in the payment landscape will require the majority of some nine million merchants to deploy new hardware in their stores within the next year, in compliance with the EMV (Europay, MasterCard & Visa) standard, and to reduce fraud levels rampant in the traditional magnetic strip system. Banks have made concerted efforts to push merchants to upgrade their POS (point of sale) systems to the ‘Chip & Pin’, widespread in Europe but virtually non-existent in the US (which still uses the traditional system). From 2015 onwards, issuers like Visa and MasterCard will no longer cover the cost of credit card fraud for retailers still on the old system. The new terminals should allow both PIN and NFC transactions, and streamlining of the online payment could also help speed up the uptake of Apple Pay.

iTunes revolutionised the music industry back in the mid-2000s. For the time being, card issuers and merchants believe that Apple Pay is a benign partner, forecasting an increase in transaction volumes to offset the fees they surrender to Apple. The transition process will take time, it remains to be seen whether this system, with its 800 million credit cards already on file (via iTunes Store), will disrupt to the payment industry on a similar scale.

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