Japan in the First Innings of a Digital Shift

By
Platinum,
03 Nov 2022

Japan was recently declared the #1 tourist destination in the world according to the 2021 Travel & Tourism Development Index.[1] Its well-deserved rise to the top should come as no surprise to those who have experienced Japan and its combination of great cuisine, unparalleled hospitality and politeness, rich cultural history, natural beauty, vibrant and safe cities, and reliable, fast transportation. With its borders finally reopening in October, Japan should now see a welcome and long-awaited boom of inbound tourism from abroad.

Yet such enthusiasm to visit Japan seldom extends to Japan’s stock market, which remains well below the 1989 bubble peak. The subsequent “lost” decades of sub-par economic growth have entrenched an unbalanced view that Japan, struggling with weak consumption, high government debt, poor wage growth, and ageing demographics, is an unattractive place to invest. Moreover, Japan appears to be slipping further behind. According to the latest 2022 IMD World Competitiveness Center rankings, Japan now ranks 34th globally for overall competitiveness, at odds with the stature of being the world’s third largest economy.[2]

This decline in Japan’s relative competitiveness reflects a number of well-trodden structural issues. These range from micro issues, such as weak productivity, employees lacking skills relevant in the digital economy, and increased competition in product markets with lower-cost Asian competitors, to macro issues, such as a lack of meaningful corporate rationalisation, managerial risk aversion, a seniority-based wage system, and a rigid labour market.

As investors, we do not see these as reasons to avoid Japan. Quite the opposite, in fact. Instead, we see tremendous opportunities to invest in companies that are trading well below their intrinsic value and taking steps to realise higher corporate value. One of the many factors that interest us is that policymakers and corporates now acknowledge that investment in human capital is key to maintaining living standards over the longer term while alleviating worker shortages and underpinning wage growth.

A recent trip to Japan by members of our investment team underscored how accelerating investment in IT and software solutions is one of the keys to unlocking latent productivity and economic growth. Japan’s IT industry has evolved differently to elsewhere, with a user preference for mainframe-based, customised IT solutions. Deployment of IT has been much slower in Japan than seen elsewhere, due in part to higher costs and perceived limited benefits. This is partly due to a high reliance on IT outsourcing, and engineering expertise tends to reside with external IT service vendors rather than in-house at user firms. However, an overdue reassessment of the benefits of IT is now occurring, spurred by the pandemic, which revealed an economy overly reliant on manual analogue processes. The government is encouraging this shift via subsidies increasing IT investment as well as mandating the adoption of digital processes through regulatory changes.

The emergence of cheaper, cloud-based package software as a service (SaaS) solutions means that IT can now be readily adopted by a broad range of enterprises seeking to raise productivity. Corporates now increasingly view such solutions as a tool to boost growth while lowering costs and addressing labour shortages. It is not surprising that corporate IT budgets continue to rise in absolute and relative terms, and we can also see an underlying shift in that spending. Since 2016, demand for packaged software (including cloud-based software) has been rising steadily in a period when demand for custom software has stagnated (see Fig. 1). With the latter being some 4x as large, we can see there is massive scope for ongoing growth in packaged software. Japan has several years of digital catch-up ahead, and the recurring message we heard was that the economy is only in the first innings of this significant structural shift. While this implies a new leg of sustained growth for the IT services industry, we should also expect the benefits of improved productivity to flow through to better corporate performance, which could underpin higher valuations in a market that remains cheap.

Travelling to Japan is now cheaper with the fall in the yen, making a holiday there even more enticing. Visit soon though, as it is unlikely that Japan will be on sale forever.

Fig. 1: Japan Tertiary Industry Activity Index - Software Services (2015 = 100, seasonally adjusted)

 Japan-innings-fig1.png

[1] https://www.weforum.org/reports/travel-and-tourism-development-index-2021/digest
[2] https://www.imd.org/centers/world-competitiveness-center/rankings/


DISCLAIMER: This information has been prepared by Platinum Investment Management Limited ABN 25 063 565 006 AFSL 221935, trading as Platinum Asset Management ("Platinum") the investment manager of Platinum World Portfolios plc ("PWP"). Platinum World Portfolios plc ("Company") is an investment company with variable capital incorporated with limited liability in Ireland with registered number 546481 and established as an umbrella fund with segregated liability between sub-funds pursuant to the European Communities (Undertakings for Collective Investment in Transferable Securities) Regulations 2011 (as amended) ("UCITS Regulations").

This information is accurate at the time of publication. This information is general information only and has not been prepared taking into account any particular investor’s investment objectives, financial situation or needs, and should not be used as the basis for making an investment decision. You should obtain professional advice prior to making any investment decision.

The market commentary reflects Platinum’s views and beliefs at the time of preparation, which are subject to change without notice. No representations or warranties are made by Platinum as to their accuracy or reliability. To the extent permitted by law, no liability is accepted by Platinum or any other company in the Platinum Group, including any of their directors, officers or employees, for any loss or damage arising as a result of any reliance on this information.

Investing is not without risk. Neither Platinum, any company of the Platinum Group, nor any of the respective directors and officers of the aforementioned, guarantee the performance of any investment product, strategy or fund referenced herein, the repayment of capital, or the payment of income. Past performance is not a reliable indicator of future performance. Returns could be reduced, or losses incurred due to currency fluctuations.

The information contained herein is aimed at professional clients within the meaning of Article 4.1(10) of the Markets in Financial Services Directive 2014/65/EU (MiFID II) (“Professional Client”). This information does not constitute an offer or invitation to subscribe for shares in PWP and no person resident in the United Kingdom or the European Union other than a Professional Client should act or rely on this information.

Prior to making any investment in PWP, please refer to the prospectus of PWP and to the relevant Key Investor Information Document (“KIID”) and do not base any final investment decision on this communication alone.

 

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