Perspectives on Equity Investing in a Declining Population

"Is there any reason to invest in countries with declining populations?"

This is an unavoidable question for portfolio managers specializing in Japanese equity investments. In this issue of our Strategy Focus, we have summarized below three perspectives to reconcile sustainability contributions and investment returns in Japan, using a declining population as a starting point.

Quick Review: Population Dynamics in Japan

First, let's look at Japan's population dynamics in the figure below. From the year 1600 when the Edo Shogunate was established, Japan's population increased by approximately 2.5 times to 30 million over the next 100 years, and it remained fairly stable from the early 1700s to the mid-1800s. Then, after the Meiji Restoration in 1868, Japan turned to modernization, and its population began to grow rapidly. Although there was a temporary decline during World War II, the trend of population growth continued, reaching approximately 128 million people in 2008, a fourfold increase since the mid-1800s. This marked the peak of a 140-year upward trend, and Japan has since shifted to a declining population trend. Despite efforts to address the declining birthrate since 1994, results have been slow to materialize. Therefore, it would be prudent to assume that the population decline will continue in Japan for the foreseeable future.

Source: Cadira Capital Management Co., Ltd., using data from the Ministry of Land, Infrastructure, Transport and Tourism's "Long-term Outlook for the Nation" (1) and the Ministry of Internal Affairs and Communications' "Population Estimates" (2).

How should companies address the challenges of a declining population and contribute to value creation? Below we describe our three perspectives on investing in Japanese equities. These are all areas where investors can make a difference through engagement, addressing demographic change and contributing to the sustainability of society.

Investment Perspective #1: Business Portfolio Restructuring

It is well known that the Japanese legal system has made it difficult to restructure companies and adjust employment levels, which has prevented the streamlining of business portfolios. Especially since the prolonged economic stagnation from 1990 onwards, companies have found themselves with excess labor, and low-profit business segments have been kept just to maintain employment. This has led to problems such as inefficient dispersion of internal resources at the company level and excessive competition and declining productivity in mature industries at the industry level.

However, the situation in which companies find themselves is changing as the population declines. There is no longer a need to maintain unprofitable businesses unless there is a surplus of labor. Rather, now that there is a shortage of labor, it makes sense to focus limited resources on core businesses with cases already emerging. Hitachi, Ltd., for example, has undertaken a bold restructuring of its business portfolio over the past decade, transforming itself from a typical conglomerate into now a social infrastructure management company integrating IT.

Indeed, there is growing momentum to support this trend. Two notable changes have occurred this year, and an environment conducive to corporate restructuring is taking shape.

One change is the relaxation of the tax system for spin-offs, making it easier for companies to streamline their portfolios through division sales. In May 2023, Sony Group Corporation announced the spin-off of its financial division using this system. Another change is the revision of the "Guidelines for Corporate Acquisition" by the Ministry of Economy, Trade, and Industry in August, making acquisition proposals more likely to be approved. In response to these guidelines, NIDEC Corporation promptly made an acquisition proposal to Takisawa Machine Tool Co., Ltd., with the expectation of finalizing the deal in October.

The change in attitudes among business leaders brought about by labor shortages, coupled with supportive policies, can lead to the restructuring of business portfolios. This, in turn, can increase corporate profits through improved operational efficiency and the elimination of excessive competition. If the resulting profits are properly reinvested, a virtuous cycle can ultimately benefit the economy and society. Conversely, if profits are not reinvested, but instead retained internally or excessively distributed to shareholders, a virtuous cycle will not materialize. To foster this positive trend, the determination of corporate leaders is critical, and the cooperative engagement of shareholders to support them will play an essential role.

Investment Perspective #2: Globalization

When we hear about globalization, many of us may feel that it's a well-covered topic. In fact, it may even seem that the trend toward globalization is reversing due to trade tensions and armed conflicts. However, if we turn our attention to Japan, we can see that "domestic globalization" is beginning to take off.

In Japan, workforce retention has become a significant challenge due to a declining population. To compensate, the number of foreign workers has continued to increase. The situation is such that about half of the population decline is offset by an increase in foreign workers, and this trend continued even during the COVID pandemic.

Incentives offered by the Japanese government play an important role. While Japan has not officially announced an open-door acceptance of immigrants, the barriers to moving to Japan have been decreasing year by year. Starting in 2019, the five-year visa limit in industries with severe labor shortages, such as construction and shipbuilding, was eliminated, and family members are now allowed to accompany the worker. From 2023, the eligible industries will be expanded to include 11 sectors, such as the service industry. In addition, highly skilled professionals can obtain permanent residency in just one year, and the required amount for a residency status like an investment visa, the "Business and Management Visa," is only 5 million yen or USD 33,333 at JPY/USD = 150.

Nevertheless, the number of foreign workers in 2022 stood at 1.82 million (*4), still less than 3% of the total population. This ratio is significantly lower than that of other advanced countries, leaving room for further expansion. In light of Prime Minister Fumio Kishida's comments in July that “we must consider a society in which we coexist with foreigners,” further changes to the immigration system are possible, and if Japan were to officially declare itself open to immigration, it could attract more people by changing perceptions.

Private sector initiatives are also contributing to globalization. The number of foreign tourists visiting Japan in August has recovered to about 85% of pre-pandemic levels.. In the short term, inbound tourism benefits activities such as tourism and shopping, but in the long term it contributes to laying the foundation for coexistence with foreigners. In addition, improvements in the accuracy of translation thanks to advances in AI are having a positive impact on "domestic globalization." In Japan, many people struggle with foreign languages that borders on incompetence, but if technology can help alleviate this discomfort, attitudes toward accepting foreigners may become more accommodating. For example, at Mercari, Inc., a person-to-person trading platform, 90 percent of the engineers hired in 2018 were foreigners. They have worked to create an environment where diverse team members can thrive, regardless of language or cultural differences. As a result, their Tokyo office now employs people from more than 50 different nationalities.

While it doesn't have to be as extreme as Mercari, Inc., it will become increasingly important to move away from the historically Japanese-dominated workforce structure and create a work environment in which workers of all backgrounds are expected to increase in number and thrive, including foreign workers. This is not only a critical perspective in selecting investment candidates, but also an area in which shareholder engagement is required.

Investment Perspective #3: Health Management

In a society with a declining population, it is important for investors to prioritize companies that place a strong emphasis on the health of their employees.

Source: Cadira Capital Management, using the data from WHO "World health statistics 2023."

Japan's total population has declined, but it is still the 11th most populous country in the world. According to WHO statistics (*5) summarized in the table above, Japan also has the highest life expectancy in the world at 84.3 years. If we compare Japan's life expectancy with the ten most populous countries in the table below, we can see that Japan's life expectancy is significantly longer.

If we look at the rankings of countries with longer life expectancy, Japan is not only known for its longer life expectancy, but also ranks first in healthy life expectancy. It's important to note that the "unhealthy period" subtracted from life expectancy, which is 10.2 years, is not significantly different from other countries. This suggests that people in Japan remain healthy for a longer period and not with the support of medical care during an unhealthy period.

It's a good choice for healthy people to find fulfillment in work. By 2022, 25.1% of people aged 65 and older in Japan were working. This is an increase of 5.6 percentage points from ten years ago (6). As noted above, the Japanese population enjoys good health, with an average healthy life expectancy of 74.1 years. Against the backdrop of a labor shortage, the ratio of job openings to applicants was 1.29 in August 2023 (7), and the unemployment rate was 2.7% (8). As a result, the employment rate of people aged 65 and over is expected to increase further in the future. For reference, other countries that have employment rates for this age group are significantly higher than Japan's, such as 41.7% in Indonesia, 37.3% in South Korea, and 32.6% in Iceland (9).

As competition for talent intensifies due to population decline, the benefits of employees continuing to work and contribute productively beyond the age of 65 are immeasurable. Of course, there are concerns about declining work performance as individuals age, but it is likely that health status is a more critical factor than age itself.

In assessing the health of employees, data on "health management" compiled by the Ministry of Economy, Trade and Industry can be valuable. They have been conducting surveys since fiscal year 2014, and outstanding companies have been publicizing their efforts as "health management brands." According to the Ministry of Economy, Trade and Industry's summary, the data suggest that health management efforts have a positive impact on operating profit margins and stock price returns (*10). The idea that good employee health leads to better performance is intuitively plausible.

In sum, it makes sense to favor companies that value the health of their employees, especially in a society with a declining population.

Investment Approach of Cadira Capital Management

Finally, we would like to briefly describe our investment approach. We invest in companies that solve social problems and create economic value and support their activities through engagement. With this investment approach in mind, we have arrived at the three investment perspectives above after examining scenarios in which solutions to Japan's social problem of population decline can be combined with economic value creation. These perspectives are also part of our engagement agenda. Supporting corporate portfolio restructuring, globalization, and health management are activities that contribute to individual well-being and economic development. Supporting these activities to ultimately generate returns on investments is the investment we seek to make at Cadira Capital Management. 

References

*1 https://www.mlit.go.jp/policy/shingikai/content/001377610.pdf

*2 https://www.stat.go.jp/data/jinsui/2.html#series

*3 https://www.meti.go.jp/press/2023/08/20230831003/20230831003.html

*4 https://www.mhlw.go.jp/content/11655000/001044540.pdf

*5 https://www.who.int/publications/i/item/9789240074323

*6 https://iris.who.int/bitstream/handle/10665/356584/9789240051140-eng.pdf?sequence=1

*7 https://www.jil.go.jp/kokunai/statistics/shuyo/0210.html

*8 https://www.stat.go.jp/data/roudou/sokuhou/tsuki/index.html

*9 https://data.oecd.org/emp/labour-force-participation-rate.htm

*10 https://www.meti.go.jp/policy/monoinfoservice/healthcare/downloadfiles/H30kenkoujumyou-report-houkokusho.pdf