Thinking Points
- Paris-based fund manager Julien Faure shares his thoughts on value investing in Japan after his August 2018 visit to Tokyo.
- Equipped with knowledge on the differences between JGAAP and IFRS accounting, Julien focuses on high quality companies trading for reasonable prices.
- His advice for investors looking into Japan? Study accounting, pay attention to the shareholder base, and look at the facts.
If you want a real-world look into value investing in Japan, you’ll like today’s post. Julien Faure is a fund manager for Amiral Gestion, a Paris-based asset management company with over $4 billion USD under management. The company holds a long term investment horizon and is fundamentals-focused. The anonymous fund manager from my recent Tokyo Takeaway series (part 1, part 2, part 3) is Julien. I’ve shared his knowledge on investing before, and he was kind enough to make the time for an interview. Hope you enjoy!
The interview
Introduce yourself! – where you’re from, what you do, how you got into investment management, etc.
I am 27 years old and come from France. I grew up in a city next to Lyon, in the French Alps. As a teenager I read an article about Warren Buffett and I was hooked. He said the best book on investing ever written is “The Intelligent Investor”, so I got a copy and started fundamental investing on my own with wages from my part-time jobs. At 18 I moved abroad to follow business studies in the Netherlands. During my studies, aside from studying Benjamin Graham & Warren Buffett, I was also reading the letters written by a group of French investors I liked: Amiral Gestion. Luckily enough I did an internship there and have worked there since.
Can you elaborate on your investment research process? – how you decide which companies to research, what you look for, and how you decide which companies are worthwhile investments.
Sure. The first part is idea generation, and I guess I do it like most fundamental investors do: reading annual reports and the newspaper, talking to companies, colleagues and industry people, looking at products in stores… Sometimes I just take a company at random in the Japan Company Handbook and start from there. I tend to not rely much on typical value screens, such as “low P/E stocks”, “negative EV screens”, because there are thousands of investors worldwide running the same screens. What edge do I have then ? These types of screens also flag a lot of companies with structural problems or bad governance, especially in Japan. Another good source for idea generation is exchanging ideas with other investors.
What I essentially look for is a bargain, but there are as many definitions of a bargain as there are investors. I define it as buying an asset at a great price relative to its quality. The larger part of my portfolio today are high-quality businesses where I have a strong confidence in the capacity of the business to grow FCF in the next 5 years and fend off competition. The rest of the portfolio is composed of typical value stocks with some type of identified catalyst which may cause the multiple paid by investors to increase.
After finding a promising company, the work consists in going through the financials and building a model, assessing the quality of the company (which we grade between 0 and 10 at Amiral Gestion) and talking to the firm, the competitors, etc. I invest only if I can identify my edge, which I believe can fall into several buckets: informational or behavioral. For instance, if my opinion is that the stock is not followed enough by other investors, or if I believe a new product has much better prospects than what the market gives it credit for, that’s informational. On the other hand, maybe I believe other investors are not paying much for a business because it’s boring, or the share price has dropped too severely due to short-term concerns, that’s behavioral. (Some investors call this “time arbitrage” which is essentially taking advantage of the fact that a company with good long-term prospects is disregarded by the market because it is likely to suffer from a few bad trimesters for non-structural reasons. A current example is manufacturing businesses with pricing power suffering from raw material price increases).
It’s difficult to have an edge, most of the time you don’t. Having an informational edge is harder when the stock is widely followed by the investing community, hence my focus on smaller Japanese firms, like you do.
What got you looking into Japan?
After joining Amiral Gestion I started working on international stocks, with no country restrictions. One day my colleague Louis D’Arvieu, fund manager, came to me and proposed to join him on a Japan research trip because he found several high-quality companies trading at very cheap prices. And not much followed by analysts! That was 2015-2016, when other markets were becoming pricey. I liked that first trip a lot, the country, the culture, the endless possibilities for stock-picking (more than 3,600 listed firms!). When we came back to France I started to focus full-time on Japan.
What other markets do you invest in?
Personally I look at all markets, but because I want an edge to invest and focus on Japan, the vast majority of investments I do are in Japan. Bruce Greenwald made an interesting comment in a video interview on this topic and the importance of being a specialist:
If I’ve been doing South Texas Gulf Coast onshore oil leases for 20 years and I know the geology and I know the sellers and I know the whole market, and you come down from New York and bid against me for a lease, if you buy that lease, if you win that auction, you’ve made a bad mistake because effectively, in some sense, I sold it to you.
We are several portfolio managers in Amiral Gestion, and we invest worldwide and discuss a lot of stocks on a daily basis. In terms of our current investments, we find interesting ideas in Europe, Asia and Japan nowadays.
What are some of the key differences you see in business culture, management style, investor behavior, etc in Japan compared to France or some of the other markets you’ve seen?
Business culture
I found Japanese business culture to be fascinating, notably the importance of long-term business relationships. My first investment in Japan was an industrial company which refused to talk to us on the phone and asked that we visit Osaka if we wanted to talk to them. After that first visit we’re now able to discuss things on the phone between our yearly visits. Another anecdote is that I recently revisited a company I first met two years ago, and the IR person still had my business card ! There are many articles & books about the other aspects of Japanese business culture: the lifetime employment, the seniority-based pay, the importance of intermediaries and introductions, the relentless focus on the quality of products etc. We currently see many interesting changes happening on that front in our investee companies. As a caveat, I have lived in Japan only for a few months in my life, so I still have a long way to go to know the ins and outs of doing business in Japan.
Management style
I have found senior managers in Japanese companies to be mostly risk-averse, conservative and focus a lot on what might go wrong. I think part of it is cultural and part of it is due to what these managers have been through in their careers: the 1989 stock market crash, followed by two decades of deflation, which is now changing under Abe’s leadership. Deflationary environments promote risk- aversion while inflationary environments promote risk-taking. I much prefer to invest in firms where managers are conservative, so this is great, but my point is that you need to be aware of it when interpreting what managers say. You can see this conservativeness in action with the famous low-ball earnings forecasts: Japanese firms’ guidance is typically overly conservative, and you should not rely too much on it. This is the contrary to Europe and the US where guidance is usually more accurate and optimistic.
Investor behavior
I think the most striking point is that most market participants have a rather short-term orientation. Turnover in the Japanese stock market is >100% per year, and up to 400% per year for the Mothers [Mothers is a section of the Tokyo exchange focused on startups and emerging companies]. Although this ratio has limitations and biases, it tells you the average share on the Mothers changes hand every trimester. To be closer to the truth you’d also need to adjust that for cross-held shares…
Secondly, you can see pretty strong reactions from investors to good or bad earnings, in a way that sometimes seems unrelated to the fundamentals. You can take advantage of if you have a longer-term horizon.
Finally, one last important trend is that the percentage of shares owned by international investors has been steadily increasing from around 10% in the late 1980s to more than 30% nowadays, and this is improving important aspects for public markets like shareholder communication, English disclosure etc. I think this trend started in the end 90s with the “accounting big bang”, the introduction of consolidated accounts, consolidated cash flow statements, and fair-value accounting. Things improved again in the late 2000s with the introduction of XBRL. Even over the last 5 years, you notice pretty dramatic improvement in shareholder communication, and this is flowing from the top-down, large-cap companies first, then smaller ones.
What were some of your best investments and worst mistakes?
My worst mistake is a French pharmaceutical stock called Stallergènes, where I suffered a 50% permanent loss of capital. The company is a worldwide leader for allergy treatments, and came up with a novel product: sublingual immunotherapy (an efficient treatment for allergies where painful & time-consuming injections are not required: you just put a small pill under your tongue every day). The market was effectively a duopoly and the company had strong barriers to entry, scale, and excellent growth prospects. An unfortunate turn of events happened. The majority shareholder forced upon minority shareholders a merger with a company he fully owned at a dubious price. As problems don’t come alone, the implementation of a new ERP caused terrible production problems resulting in some allergy treatments being sent to the wrong patient ! The health authorities had to prevent the firm from doing business for a while. The share price dived and did not recover. Lessons learned: a moat is not enough, and make sure that majority shareholders have your best interest in mind.
Luckily in Japan, I have never suffered permanent loss of capital, although I haven’t invested there over a full cycle, so maybe we should talk again in 5-10 years. Hopefully I won’t have too many to discuss by then. My worst investments in Japan so far have been value traps. Your risk of permanent loss with them is minimal, but my observation is that the opportunity cost of owning them over long-periods of time can be huge.
My best investment in Japan has been a company called Avant (3836), a software business with a high market share in the consolidated-accounting niche. The company, founded 2 decades ago, developed a great software which is now used by the largest companies in the country to consolidate their accounts. The firm is currently undergoing a business model shift towards higher-margin BPO services, to help clients with the tasks they can’t do themselves in a cost-efficient manner. The company is ran by a talented and entrepreneurial management team which has skin in the game.
If you had to choose 3 most important factors for investors to pay attention to in Japan, what would they be?
Fundamentally, you assess a business the same way as anywhere else. And markets are governed by greed, fear, impatience, which is the same as anywhere else. But there are a few Japan-specific factors to keep in mind:
- Spend some time on getting familiar with the intricacies of J-GAAP. Some differences with IFRS are goodwill amortization (mandatory, which makes reported profits a bad proxy for cash generation in acquisitive firms) and sales recognition methods (which can make margins appear lower than under IFRS).
- Pay particular attention to who are the main shareholders. Also, what is their priority for the firm ? You need to be cognizant of the fact that the place of shareholders in Japan is different than in the Western world. There is a big emphasis on duties to clients, suppliers and society as a whole first. So the concept of shareholder primacy does not hold.
- Look at the facts. There are several cliches about Japan and its companies, which bears hold as reasons for not investing there: there’s no inflation, balance-sheets are bloated, payout is too low, population is declining, etc. In many cases I have found these cliches to be inaccurate or not affecting my investment thesis. So I like to read the Nikkei, the METI reports and look at figures and hard data.
Reach out to Julien
If you’d like to get in touch with Julien, you can either contact him through LinkedIn or fill out the Kenkyo Contact Form and I’ll forward your message to him!
