Growing interest
26 Jul 2023
Apex’s Mark Bennett talks to Brian Bollen about Japan’s economic outlook, its domestic demands, and its influx of foreign investors post-pandemic
Image: Apex
“Japan has been undervalued for years,” says Apex’s Mark Bennett, country head of Japan. “The yen has weakened as interest rates have risen around the world, and asset prices have remained subdued over the past 30 years.”
After moving to the country in 2009, Bennett knows a thing or two about Japan and its economics. He joined Sanne in 2019, focusing on real estate and asset servicing, and now works for Apex, following its acquisition of Sanne a year ago. Based in Tokyo, he continues to use his expertise to help grow Apex’s strength in the region. He also serves as the group’s representative director for Japan.
“Japan has an established economy; it is comfortable with its size and identity, and represents a very attractive investment environment,” Bennett tells Asset Servicing Times. “If you want to invest in Asia, Japan is the largest and most diverse market. Japan is a more open market to foreign investors than ever before, because it needs to be.”
While domestic investors remain wary, their international counterparts see opportunities for the long term. Investment in data centres is projected to return yields of 6 to 7 per cent over 20 years. The country’s attractiveness to international investors also presents opportunities for non-Japanese asset services providers, catering to the needs and demands of inward investors.
In March 2022, the executive board of the International Monetary Fund (IMF) concluded a consultation with Japan and published its own assessment. It began with the observation that the economy continues to recover, while a weaker global economy has been weighing on external demand.
Private consumption led the recovery, and private investment also rebounded. Industrial production recovered strongly during the summer of 2022; as pandemic lockdown rules eased, supply chain constraints lessened.
A year down the line, Bennett identifies bank-owned providers such as State Street, BNY Mellon and J.P. Morgan as ‘prominent international names’ that are active in Japan in 2023 — modestly conceding that the independently-owned Apex is somewhat smaller at present.
Another potential driver for international service providers is outward investment, although Bennett takes care not to overstate its magnitude both in the present and when making predictions.
“There are investors here who want to invest, as is demonstrated by the statistic that around a quarter of all assets in the Cayman Islands are owned by Japanese investors,” he says.
“The Japanese market has become attractive to large global asset managers, particularly real estate asset managers,” Bennett continues. This is evident when considering the large global managers that have opened or reopened in Japan in the last five years. Among these are property management company Greystar, private equity firm Starwood Capital, and Hines Real Estate.
Real estate
In large cities such as Tokyo, Osaka and Fukuoka, the demand for new residential development is high. The population is ageing, and while rural Japan is becoming desolate, Japan’s largest cities have housing stock that is less than 40 years old and already in need of regeneration.
Japan’s Financial Services Agency has been working to help the corporate debt market develop, particularly over the last 20 years, Bennett explains. Much of the debt is held on corporate balance sheets, including what has come to be known as ‘non-performing debt’. The Japanese Accounting Standards Board does not require mark-to-market valuations in financial statements, so they remain at book cost.
“As and when International Financial Reporting Standards becomes an accounting standard in domestic Japan, it is likely that there will be big write downs and a much greater drive towards debt securitisation,” Bennett affirms.
On the macroeconomic front, he says that it “remains unlikely that Japanese central bank interest rates will rise back to zero, or increase above zero.” Underlying inflation in Japan is still less than 4 per cent, and will likely fall below the Bank of Japan’s medium-term target of 2 per cent.
“Wage growth in Japan has been low over multiple decades. Unions are not aggressively pushing for higher wages, and while pockets of the economy such as finance are seeing some increases in wages, it is not a broad market growth,” he says.
Company demographics are another area to analyse: “Some 99 per cent of all companies in Japan would be considered small- or medium-sizes enterprises (SMEs),” estimates Bennett.
He adds: “In many cases, they have issues with succession plans. Family sizes have dropped considerably, large metropolitan centres have increased significantly, and other countries such as China and Korea have taken business away from Japanese companies. It is likely that many of these SMEs will either cease to exist, or will need to merge to survive.
“Corporates in Japan are holding near record levels of cash, which given the zero interest rate environment is a drag on return on investment and equity. The share buyback schemes seen in places such as the US are not as prevalent in Japan.
“At some point, these cash reserves will need to be invested or returned to shareholders in the form of dividends or buybacks. We would expect that while private equity has a part to play in Japan domestically, given the low borrowing costs locally, it is unlikely that many companies will be seeking to add private equity investors to their capital structure.”
Socioeconomics and maintaining stability
As Japan’s immigration is less than 2 per cent, it is unlikely that the issue of an ageing population can be realistically mitigated any time soon. Japan has a well-publicised level of government debt, as much of this is held by the older generations.
Given that inheritance tax is up to 50 per cent, it is likely that the Ministry of Finance (the Japanese Treasury) will use these incoming taxes to pay back the debt.
“Given that most Japanese government bonds are held by Japanese citizens, corporations, institutions and pension schemes, there is a more limited risk related to these Japanese government bonds than would be the case in other markets such as the US, where treasuries are held by a broader global set of investors,” Bennett highlights.
The Bank of Japan has found that the country’s wider financial system has been maintaining stability. It outlined this view in a report released in April 2023, the findings of which suggested that Japanese banks have sufficient capital bases to perform financial intermediation activities appropriately — even amid the global tightening of financial conditions and the resultant various types of stress. Additionally, despite heightened uncertainty about the financial sector in the US and Europe triggered by some US bank failures in March, Japan’s financial system has been sound and resilient, the report found.
Although the quality of banks’ domestic and foreign loan portfolios has remained high on the whole, some loans entail high credit risk. From a long-term perspective, if banks’ core profitability was to stagnate and capital accumulation was to stall, financial intermediation could be impaired due to a decline in loss-absorbing capacity, the Bank of Japan said. Additionally, vulnerabilities in the financial system could increase through excessive search for yield.
“To ensure the stability of Japan’s financial system, it is necessary to examine these risks of contraction and overheating in the financial system, and to address potential vulnerabilities appropriately,” it added.
After moving to the country in 2009, Bennett knows a thing or two about Japan and its economics. He joined Sanne in 2019, focusing on real estate and asset servicing, and now works for Apex, following its acquisition of Sanne a year ago. Based in Tokyo, he continues to use his expertise to help grow Apex’s strength in the region. He also serves as the group’s representative director for Japan.
“Japan has an established economy; it is comfortable with its size and identity, and represents a very attractive investment environment,” Bennett tells Asset Servicing Times. “If you want to invest in Asia, Japan is the largest and most diverse market. Japan is a more open market to foreign investors than ever before, because it needs to be.”
While domestic investors remain wary, their international counterparts see opportunities for the long term. Investment in data centres is projected to return yields of 6 to 7 per cent over 20 years. The country’s attractiveness to international investors also presents opportunities for non-Japanese asset services providers, catering to the needs and demands of inward investors.
In March 2022, the executive board of the International Monetary Fund (IMF) concluded a consultation with Japan and published its own assessment. It began with the observation that the economy continues to recover, while a weaker global economy has been weighing on external demand.
Private consumption led the recovery, and private investment also rebounded. Industrial production recovered strongly during the summer of 2022; as pandemic lockdown rules eased, supply chain constraints lessened.
A year down the line, Bennett identifies bank-owned providers such as State Street, BNY Mellon and J.P. Morgan as ‘prominent international names’ that are active in Japan in 2023 — modestly conceding that the independently-owned Apex is somewhat smaller at present.
Another potential driver for international service providers is outward investment, although Bennett takes care not to overstate its magnitude both in the present and when making predictions.
“There are investors here who want to invest, as is demonstrated by the statistic that around a quarter of all assets in the Cayman Islands are owned by Japanese investors,” he says.
“The Japanese market has become attractive to large global asset managers, particularly real estate asset managers,” Bennett continues. This is evident when considering the large global managers that have opened or reopened in Japan in the last five years. Among these are property management company Greystar, private equity firm Starwood Capital, and Hines Real Estate.
Real estate
In large cities such as Tokyo, Osaka and Fukuoka, the demand for new residential development is high. The population is ageing, and while rural Japan is becoming desolate, Japan’s largest cities have housing stock that is less than 40 years old and already in need of regeneration.
Japan’s Financial Services Agency has been working to help the corporate debt market develop, particularly over the last 20 years, Bennett explains. Much of the debt is held on corporate balance sheets, including what has come to be known as ‘non-performing debt’. The Japanese Accounting Standards Board does not require mark-to-market valuations in financial statements, so they remain at book cost.
“As and when International Financial Reporting Standards becomes an accounting standard in domestic Japan, it is likely that there will be big write downs and a much greater drive towards debt securitisation,” Bennett affirms.
On the macroeconomic front, he says that it “remains unlikely that Japanese central bank interest rates will rise back to zero, or increase above zero.” Underlying inflation in Japan is still less than 4 per cent, and will likely fall below the Bank of Japan’s medium-term target of 2 per cent.
“Wage growth in Japan has been low over multiple decades. Unions are not aggressively pushing for higher wages, and while pockets of the economy such as finance are seeing some increases in wages, it is not a broad market growth,” he says.
Company demographics are another area to analyse: “Some 99 per cent of all companies in Japan would be considered small- or medium-sizes enterprises (SMEs),” estimates Bennett.
He adds: “In many cases, they have issues with succession plans. Family sizes have dropped considerably, large metropolitan centres have increased significantly, and other countries such as China and Korea have taken business away from Japanese companies. It is likely that many of these SMEs will either cease to exist, or will need to merge to survive.
“Corporates in Japan are holding near record levels of cash, which given the zero interest rate environment is a drag on return on investment and equity. The share buyback schemes seen in places such as the US are not as prevalent in Japan.
“At some point, these cash reserves will need to be invested or returned to shareholders in the form of dividends or buybacks. We would expect that while private equity has a part to play in Japan domestically, given the low borrowing costs locally, it is unlikely that many companies will be seeking to add private equity investors to their capital structure.”
Socioeconomics and maintaining stability
As Japan’s immigration is less than 2 per cent, it is unlikely that the issue of an ageing population can be realistically mitigated any time soon. Japan has a well-publicised level of government debt, as much of this is held by the older generations.
Given that inheritance tax is up to 50 per cent, it is likely that the Ministry of Finance (the Japanese Treasury) will use these incoming taxes to pay back the debt.
“Given that most Japanese government bonds are held by Japanese citizens, corporations, institutions and pension schemes, there is a more limited risk related to these Japanese government bonds than would be the case in other markets such as the US, where treasuries are held by a broader global set of investors,” Bennett highlights.
The Bank of Japan has found that the country’s wider financial system has been maintaining stability. It outlined this view in a report released in April 2023, the findings of which suggested that Japanese banks have sufficient capital bases to perform financial intermediation activities appropriately — even amid the global tightening of financial conditions and the resultant various types of stress. Additionally, despite heightened uncertainty about the financial sector in the US and Europe triggered by some US bank failures in March, Japan’s financial system has been sound and resilient, the report found.
Although the quality of banks’ domestic and foreign loan portfolios has remained high on the whole, some loans entail high credit risk. From a long-term perspective, if banks’ core profitability was to stagnate and capital accumulation was to stall, financial intermediation could be impaired due to a decline in loss-absorbing capacity, the Bank of Japan said. Additionally, vulnerabilities in the financial system could increase through excessive search for yield.
“To ensure the stability of Japan’s financial system, it is necessary to examine these risks of contraction and overheating in the financial system, and to address potential vulnerabilities appropriately,” it added.
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