Why Japanese Stocks Could Outperform with Howard Smith - FEG Insight Bridge
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Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I'm your host, David Stein, and in this episode, we'll release our second in our monthly series of podcast episodes produced by my former institutional investment advisory firm, FEG Investment Advisors. Their podcast is the FEG Insight Bridge.

hosted by Greg Dowling, FEG's Chief Investment Officer and Head of Research. Greg and I worked together for years as part of FEG's Investment Committee. In this episode, Greg interviews Howard Smith of Indus Capital. Indus is an independent, partner-owned asset management firm that focuses on Asian Pacific equities.

Howard is a partner at Indus and portfolio manager for the Indus Japan Strategies. He has spent almost his entire 30-year-plus career following and investing in Japan, and

including living a large portion of his adult life there. Warren Buffett, in Berkshire Hathaway's recently released shareholder letter, mentioned it had been six years since Berkshire began purchasing shares in five Japanese companies that he said very successfully operate in a manner somewhat similar to Berkshire itself.

Buffett continued, we simply looked at their financial records and were amazed at the low price of their stocks. Berkshire anticipates increasing its ownership in these Japanese companies. Yet, in previous episodes of Money for the Rest of Us, we've discussed some of the challenges Japan faces with an aging population, high national debt balance, and extended periods of stagnant prices.

Japan is one of my favorite places to visit, so I was intrigued when FEG decided to dedicate an episode on investing there.

Smith mentioned some of his favorite things about Japan, but this is his statement that really caught my attention. Japan is coming out of a long era of very low economic growth and low inflation and kind of a loss of relevance in many respects. But I don't think that's a permanent state of affairs. And I think over the next 10 years, we're all going to be rather surprised by Japan.

Smith addresses what he calls the false narrative that Japan is a difficult place to invest and doesn't really produce good returns. He also explains why he isn't worried about Japan's national debt and how it differs from the U.S. in that regard. Smith also addresses why he believes the Japanese yen is tremendously undervalued.

Over the past decade, ending January 2025, the MSCI Japan index has only returned 6.2% in U.S. dollar terms. In yen, however, Japanese stocks have returned over 9% annualized. In other words, a weakening yen lowered returns by 3% annualized.

Japanese stocks have also gotten cheaper over the past decade, reducing returns by 0.9% per year. The MSCI Japan index is selling at 14 times expected 12-month earnings, compared to 22 times expected earnings for U.S. stocks. So let's explore the case for investing in Japan as laid out by Howard Smith of Indus Capital.

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Here's Greg Dowling and Howard Smith on FEG's Insight Bridge. Howard, welcome to the FEG Insight Bridge. Thank you for having me, Greg. It's great to see you again, and it's an honor to be on your podcast today. Would you introduce yourself and Indus?

Absolutely. So my name is Howard Smith. I'm a partner at Indus Capital Partners. Next year, we'll be celebrating our 25th anniversary. The firm was founded in the year 2000 by a group of people who had been working with George Soros and Stanley Druckenmiller, investing in the Asia-Pacific equity markets in public equities. And that's what we've been doing for the last two and a half decades. I am the Japan guy, so I run two dedicated Japan funds. And

And we have two other products that invest in the broader region, including Japan. So a total of four funds. So how did you get interested in Japan? I think it was very much a product of when I was born and the era in which I grew up. Greg, and maybe you have some similar sentiments through your early years. I'm thinking of like the 1980s song, Vabers, the turning Japanese. Turning Japanese. I really think so. Yes.

I graduated in 1988 from college in the UK, and that was pretty much the peak of Japan's asset bubble at that time. This was the era of Japan as number one.

when US auto workers were smashing up Mitsubishis and Nissans on the streets of Detroit, Japanese companies buying the Rockefeller Center and Pebble Beach golf course. So it was just a place that was very much in the news. I was an economics major. Everyone was telling me that this is really different. They do things differently over there. And we've got a lot to learn from them. The West needs to kind of sit up and notice and learn from this country.

So I really thought I wanted to spend some time in Japan. I got on a plane and I flew out on Aeroflot, which was the Russian airline from London Heathrow, stop in Moscow on the way. And then I got to Japan in late 1988. Initially taught English because that's what a lot of people did in those days. The newspaper, the English language newspaper had a section of like 60 pages in the middle for job ads.

But for English teachers, that's how I began. And then started in finance with Nomura not long after that.

And spent four years in Japan at that time, you know, around the bursting of the bubble and the, you know, saw both the peak and the beginning of the downslope after that. And that really triggered in me a lifelong love of Japan. My whole working career has been centered around Japan ever since. That's amazing. It's too bad, though, in school, they didn't tell you in 88 that the peak was going to be in 89. I know, I know.

Even as late as December 89, when the Nikkei was 40,000, everyone was saying it's going to 60 next year and then 80 and then 100. And they were, of course, inventing all sorts of exotic reasons as to why that was going to be the case and why valuations were going to continue expanding. And I think we've heard various versions of that story throughout economic history, but I'm sure it won't be the last.

It didn't quite pan out that way, and things sort of took a turn for the worst around 1990. And that period of the downslope, I think, really continued until about 2012, 2013. You know, we had over 20 years of that. And the last 10 years have been much different and much better. And I'm sure we'll talk about that as we go along. You know, starting back to just culturally, I've had the opportunity to travel everywhere and a lot in Asia.

I always feel like Japan is so different. Can you describe some of the cultural differences of Japan versus the West? It's been an advanced industrialized nation since the end of the 19th century. So,

So Japan restored its emperor in 1868 and built a modern industrialized society in the final quarter of the 19th century, and of course built a big military capability as well, which got Japan into trouble later on. So I think there's been a deep connection between the West and Japan forever.

for 150 years now. And I think that makes Japan culturally very familiar in many ways. First world country with wonderful infrastructure. It's incredibly clean and safe. The food is amazing. And that's not just Japanese food. That's sort of French and Italian food as well.

So at one level, it feels very, very familiar. But of course, it's a Confucian Buddhist Shinto society. So the spiritual belief system is very different. I think the way that people organize themselves into groups is different. It's at some level more of a consensus-driven society, maybe a little less in the way of animal spirits compared to a country like the United States. A desire for harmony and consensus is

I desire perhaps not to rock the boat so much.

But behind that, there's a quiet determination and an ability to adapt and change. And I think one of the amazing things about Japan is that it's always evolved and reinvented itself and found a way to stay relevant on the world stage. And I think that's precisely the inflection point we face at the moment. You know, Japan is coming out of a long era of a very low economic growth and low inflation and kind of a loss of relevance in many respects.

But I don't think that's a permanent state of affairs. And I think over the next 10 years, we're all going to be rather surprised by Japan again.

Not sure we're going to be talking about Japan's number one again in quite the same way that we did in the 1980s. But I think we're going to be pleasantly surprised by just how important Japan is as an economy and as a partner for countries like the U.S. and blocs like the EU. You probably know for sure, but I don't think that Nikkei regained its

It's top until like last year, maybe? Is that right? It was, I think, this year, actually, Greg. Yeah. Yeah, this year. Okay. Yeah. It's been a long slumber. So what does the economy look like? What are the major industries in Japan now? And how has that changed when you first started? So Japan is a mature, advanced economy, just like the United States. So the service sector is the biggest part of the economy.

But Japan still has a larger industrial manufacturing base than a country like the US. Manufacturing is about 20% of GDP in Japan. It's only 10% or 11% in the US. So the service sector is much bigger in the US relative to Japan. Japan is still a very big player in manufacturing areas like automotive.

Toyota is equally as big as Volkswagen and bigger than General Motors and Ford these days. It has a much larger market share in many markets than a firm like Volkswagen. There's other big automotive companies like Honda and Nissan that are still very big players globally. It's an extremely big player in the semiconductor value chain. So the production equipment, the wafers, the intermediate materials,

And increasingly, again, the downstream manufacturing of semiconductors themselves, you know, that's making a comeback in Japan. It's a big player in areas like factory automation and robotics.

material science. The Boeing 787 is mostly made out of carbon fiber produced by a Japanese company. So Japan is a leading player at the edge of lightweight, high tensile materials. And I think that's going to play an important role in areas like carbon reduction going forward as we try to decarbonize the economy. So still a very high tech, high value added manufacturing society.

But also the developer and owner of a number of global brands. If you look at the video gaming industry and companies like Nintendo and Sony, they are global players in content for video games, and they are extremely dominant in certain niches.

There's other Japanese brands like Uniqlo, which is a big clothing company that is making very deep inroads now into the US and European markets. So I think the soft power of Japanese brands, particularly consumer-facing brands, is growing rapidly.

You know, the Japanese are taking on the Swiss in certain areas with high-end watches, for example. Grand Seiko is now mentioned in the same breath as Rolex and Omega as a very important watch manufacturer. So I think in the sort of B2C area, Japan's making a little bit of a comeback. And of course, we saw that in 70s and 80s with the Walkman and the original game consoles back then. So I think we're going to see more of that.

But behind the scenes in the B2B domain, particularly in semiconductors, I think Japan's going to be a critical player in the production of semiconductors. And that includes AI. No NVIDIA chip is going to be made without a lot of input from Japanese companies somewhere in that value chain. They're really important there as well.

These are important industries for the future. It feels like Japan is kind of at that nexus where they need to be a part of this. And so I think that's helpful for people to think of. I mean, I think most people would go, okay, Toyota, what else do they do? I mean, there's so much on the robotics and manufacturing, advanced manufacturing that they do. When you come out of school, you're probably super popular. You're the Japan guy. And then nobody wanted to talk to you for, I don't know, 20, 30 years.

Maybe 20 years, because I felt like there was this resurgence in Japan...

When Abe became the prime minister, there's three arrows. Japan's going to rise and it's going to be amazing. And it kind of just fizzled out. Did those three arrows, did they just take longer to bear fruit? Like, talk to us a little bit about then and now, because, you know, about 10 years have passed. I completely agree with that assertion, Greg. I mean, I think Japan was very ready for Abe at the end of 2012, beginning of 2013. Yeah.

Japan was a very depressed place back then. The stock market was at post-bubble lows around that time. The Nikkei had gone below 10,000. It's now back at 40,000.

There'd been a tremendous natural disaster the previous year in 2011, huge earthquake and tsunami, which led to the deaths of thousands of people. There was a nuclear accident as a result of that. Fukushima. So Japan was in a pretty bad spot, I think, psychologically as a nation and was very ready for new ideas and a kind of renaissance or resurgence. So really Abe to me was about two things.

The first two arrows, which are monetary and fiscal policy, really, to me, are the same thing. It's about reflating Japan, right? It's about getting CPI from minus 0.5% a year to plus 2% a year. And with that, you know, nominal GDP growth from effectively zero to 2% to 3% a year. And with that, you know, you would hope that companies start to develop pricing power again, that

people have a different attitude to risk-taking, that the velocity of money in the economy picks up, that the half of household net worth that's in cash goes into riskier assets, all of these things. That was really the origin of the first two arrows, I think. The third arrow was about getting higher productivity growth going in Japan. It was about deregulating the economy and allowing more entrepreneurship and encouraging companies to be better managed.

So we had the Corporate Governance Code and the Stewardship Code that were promulgated in 2014 and 2015, and various ministry white papers since then that are encouraging Japanese companies to dispose of non-core assets, to unwind cross-shareholdings, to have higher asset turnover, higher return on assets. And with that, it was hoped that return on equity would also improve and stock prices would go up.

And to be fair to Abe, who's unfortunately now deceased because he was assassinated a couple of years ago, I think the scorecard is very good, actually, on pretty much all of those initiatives. You know, Japan does have 2% CPI inflation now.

It has had a massive rally in equity prices over the last 10 years. There is a new generation of entrepreneurs who are emerging in the Japanese economy. Corporate governance in Japan is remarkably different to how it was 10 years ago in terms of board independence and, you know,

attitudes to risk-taking disposal of non-core businesses. I think Japan is unfairly punished in that regard for not having made enough progress. I think the scorecard's actually a lot better than people think. But to go back to your original question, Greg, I think Japan's always suffered from this need to have a story. I think international investors set a much higher hurdle for Japan than they do in other markets, another developed market. I mean,

I mean, nobody in the US is sort of asking, what's next? Where's the next arrow coming from? What's the government going to announce now? It sort of takes care of itself, right? The private sector does its thing and companies produce EPS growth and investors like that and buy more shares. And there's a virtuous cycle there. And Japan should be the same, but for

But for some reason, there always has to be this narrative, this story. And it has its roots in this preconception that Japan is a difficult place or a troublesome place and doesn't really produce good returns. And I think increasingly, that's a false narrative. It's an incorrect narrative. And I'd like to think that in the next five or 10 years, we're going to have more evidence that

well, actually, Japan's sort of just getting on and doing it and is a decent place to do business and make money. So I think that's the inflection point we're at now. I also wonder, too, if, well, you know, certainly Global Wall Street loves stories and that's what they do. They sell stories. I also wonder if Western investors are just impetuous. Things take longer in certain parts of the world and most people probably weren't alive or...

I mean, especially probably some of the people listening to this. I mean, Japan was the mother of all asset bubbles and asset bubbles when they break are deflationary. And it just takes time to, they certainly didn't do all the things they should have done initially, right? So it kind of perpetuated for a while, but things take time. They do take time. And I think in particular in a country like Japan,

They take time. So it goes back to what we were discussing at the beginning, you know, the need to have consensus, the need to develop a sort of momentum behind an initiative or a new set of rules. You know, there were early adopters in Japan, you know, companies like Hitachi who got on this train very early and had majority board independence very early, independent board chair very early, disposing of non-core assets very early. But

Yeah, it took several years for other companies to notice that and start to behave in the same way. And there was some pressure from regulators. There was some pressure from activist investors, certainly pressure from unwinding of cross-shareholdings because that changes the nature of the relationship between managers and owners of companies. So it probably did take a decade to come together. And then, of course, we had the pandemic in the middle of that, which...

set things back for quite some time. Japan's borders were closed for two and a half years. So everything was kind of on pause, I think, during that period. But here we are again now in a post-pandemic world where I think the story is very much in a high gear and the market's pretty much at record highs. Certainly in local currency terms, there's been some currency depreciation

depreciation versus the US dollar, which has diluted the returns a bit for unhedged international investors. But the local currency asset price inflation has been strong and the local currency EPS growth has been strong. I think there's a lot more to play for. I think we're still early innings in this story. Kudos to you and me. We're one of the people, you know, say maybe a couple of years ago, we're saying like things are changing, right? And you really need to pay attention to Japan. And it felt like

kind of late last year or middle last year to up to about August of 2024, people were very excited. But it also seemed like some of that was because of Warren Buffett. Again, the story thing, like Warren Buffett bought some of the trading companies and then people were like, well, if Warren Buffett's doing it, it must be a good investment. So it felt like you were the popular person again. I mean, people wanted to talk to you, Howard. It was like you probably had more invitations to the dance than ever before. I think that's very true. I would agree with that. Although I think that

Those discussions have exposed what I would call a decay in institutional knowledge around Japan, because people haven't looked at it for 20 years. So you kind of have to go back to first principles and give people a refresher. You know, you're often talking to a new generation of people who may not have ever looked at Japan before, because a lot of people of my generation who were involved with it have kind of fallen by the wayside or gone off to do other things. I agree with you. I think interest in Japan is very high.

But I still sense skepticism and cynicism around Japan is quite high. And people are a little bit cautious around how best to express a view there and maybe a little bit nervous around the sustainability of what's going on in Japan. And in the meantime, of course, you know, the U.S. equity market's been going on to set

And, you know, Japan's market cap is about 950 trillion yen, which at this exchange rate is around 6 trillion US dollars. That's two big Mag7 companies, right? That's right. That's an NVIDIA and a Microsoft combined. That's the same size as 4,000 listed companies in Japan.

That's part of it, too, I think. There's been little incentive to be shaken out of this incredible machine that is the US equity market. But quietly, behind the scenes, in its own way, Japan is changing. Japan is producing higher prices.

returns for investors. I think we're going to see more interest and hopefully more sustained interest in Japan rather than this sort of in and out flow of capital that sees Japan as a place to park money for temporary periods while China sorts itself out or while there's a temper tantrum going on in the US or whatever it may be. But it hasn't tended to stay for very long. So that's what I'd like to see. I'd like to see more fundamental long-term commitment to Japan. I

as opposed to kind of a trading place that is just a temporary home for capital. You mentioned this kind of earlier that AI is a big part of like Japan. They make a lot of the pieces and components and advanced manufacturing, robotics, you name it. Is Japan a kind of a back way to play some of the things going on in the US at lower multiples? Maybe paint the picture. What is that opportunity to invest in Japan right now?

Yes, I mean, I think it is, but it is a backdoor way. You know, Japan doesn't have a Meta or a Google or an Amazon. I mean, it has small versions of those companies that are typically not global in reach, right? They're domestic Japanese companies. But as we were saying, in that B2B value chain...

Companies like Tokyo Electron, Adventest, Disco, Ulvac, which are all semiconductor production equipment companies. I mean, Japan has a huge role to play in that sphere, particularly at the leading edge, you know, in areas like lithography, which are incredibly difficult to do when you're talking about 2 nanometer or 1.8 nanometer lithography.

chips using an EUV production process. There's no Chinese company that's capable of doing that. And there's probably only two or three US and European companies that have the same R&D engine as the Japanese companies. The biggest silicon wafer producer in the world is a Japanese company called Shinetsu. And pretty much all of the intermediate materials like the slurries and resists are produced by Japanese companies as well.

And as I mentioned earlier, Japan is now getting back into the business of building the semi-nuclear system.

It lost that industry to Korea and Taiwan in the 1990s and early noughties. But the Japanese government is underwriting a massive two nanometer logic fab in Japan at the moment. And there's CapEx coming in from TSMC in Taiwan into Japan, coming to like Micron building in Japan. So global semiconductor companies are also putting up facilities in Japan.

I think there's going to be a renaissance of semiconductor manufacturing, both by Japanese companies and by US and European and Taiwanese companies in Japan, but all backed by a very long vertical value chain.

that is dominated by Japan. I do think that is an excellent way to get access to a long-term story in data density, artificial intelligence, eight to 10 times EV to EBITDA, or 15 to 20 times PE, as opposed to three or four times those multiples in the kind of poster child stocks that are involved in those areas. So maybe a question related to that,

A lot of the foreign actors who are putting in facilities feels like maybe they would have put those facilities in China 10 years ago. Are they benefiting from French or the China plus one strategy? How much of that do they benefit from being an alternative to China?

versus being integrated in China, because the Japanese also manufacture a lot in China. So maybe talk about that interesting balancing act they have. You're absolutely right, Greg. I mean, Japan, I think at some level is caught between a rock and a hard place in its relationship with China. It's allied with the United States.

There's a US security umbrella protecting Japan, and that's been in place since the end of the Second World War and will remain a very important part of the relationship between Japan and the US. So Japan will always be aligned with Washington, D.C. in its approach to dealing with China economically.

But China's also a very important market for Japanese producers and a production base for Japanese manufacturing companies. But I think as we disentangle supply chains from China, Japan's going to be a beneficiary of friend shoring or reshoring. And we're clearly seeing that in the semiconductor value chain. Clearly seeing that. TSMC is very happy with the fabs it's built in Japan already. You've got a highly skilled workforce. You've got excellent infrastructure.

you've got good intellectual property and a good R&D base in Japan. TSMC's had a better experience building in Japan than they have in Arizona, where it's hard to find skilled engineers. Japan has abundant freshwater resources because it rains a lot in Japan and it doesn't rain so much in Arizona. So you need a lot of clean water to make semiconductors. I think Japan is naturally very well placed to be

a beneficiary of friend shoring or reshoring as the world disentangled itself from China, particularly at this exchange rate, because Japan is cheap. You know, if you convert a skilled engineer's wages into dollars at this exchange rate, they are way lower than you would have to pay in the United States. The cost of freight and transport is way lower. Japan is very, very well placed, I think, in that regard.

The relationship with China, I think, is going to be fraught with difficulty. But Chinese consumers, just like US consumers, are in love with many Japanese brands. If you look at Uniqlo in China, it's doing very well. You know, we're invested in a revolving conveyor belt sushi chain that is opening stores in China. And there's, you know, hundreds of people curled around the block waiting to get into the restaurant. So, you know,

Japan has a sort of love-hate relationship with China, and it's always going to be a big market, I think, for Japanese brands, but maybe a less important market for Japanese manufacturers, much of which is going to come back into Japan. And of course, the Chinese government is very keen to build its own semiconductor industry, its own automotive industry.

And so there's an import substitution angle that is squeezing out multinational companies. And you can see this with Volkswagen and GM and international companies that are losing market share in China as the Chinese government builds out its own indigenous domestic industry. And Japan will certainly suffer from that to a certain extent. But I think we'll have a net gain in aggregate

with capacity coming back onshore in Japan, which is a very competitive place to make things at this exchange rate. So we talked about a couple of the positive attributes as being a way to play tech, a way to play friend-shoring, but it's not all rainbows and butterflies. If things were going great this year and then we had this huge unwind of the yen carry trade, can you talk about what happened and how come it caused damage around the world? For

For all of us who don't understand the yen carry trade, how could that happen? I mean, I wish I had the perfect answer to that question, Greg, because I'm not sure I know how it happened. I thought I'd seen everything. I was investing through the global financial crisis, the Fukushima disaster, the COVID shock in 2020. That three-day period in early August actually exceeded all of those events in terms of the magnitude of the change. Right.

I mean, I think it tells you there was an enormous weight of capital playing that interest rate differential between the US and Japan. So, you know, Japan still has 25 basis point overnight interest rates. The US has 475 basis point overnight interest rates. So it's been everyone's favorite trade, you know, to borrow in yen and put that money to work elsewhere.

And it was clearly a very crowded trade. So as Japan went from zero rates to 25 basis point rates in July, and as the narrative from the Fed started to become much more dovish, and we had a 50 basis point rate cut from the Fed, I think a panic set in and there was a very violent unwind of that carry trade.

Ironically, if you fast forward to today, it seems to have reasserted itself somewhat because, you know, the narrative around US rates has changed yet again. You know, we're still groping for whether it's going to be a soft landing, a hard landing or no landing. You know, US rates are all over the place and the dot plots are constantly changing. I think that whole carry trade is defined by the interest rate differential between Japan and the US. But I do believe it's going to narrow going forward. I do think Japan needs to raise rates further. You know,

Japan's inflation has been running hot for some time now. Wage inflation is very robust. Real incomes are growing in Japan. That will increasingly not justify a 25 basis point overnight interest rate.

And I don't know the exact timing of further US rate cuts, but I'm pretty sure we are going to get some form of further rate cuts. I'd be very surprised if we stay at 475 basis point overnight rates. I know the US economy is exceptional and it's strong and the labor market seems to just go on like a steam train.

But I think we're in some gentle form of a slowdown here, and I think rates are going to come lower. So I still find the yen profoundly undervalued at this exchange rate. It's still at a 50-year real effective low. Anyone getting off the plane in Japan will see immediately that their sushi lunch is $8 there, and it's $32 in New York City. So something is wrong with that equation. So...

I think the carry trade has to unwind further. I just hope it doesn't take place in such a violent, dramatic form as we saw in the first three days of August. A more gentle appreciation of the yen, I think, would be the most constructive development. But a year from now, I would fully expect the yen to be stronger against the dollar than it is today as rates narrow, as the differential narrows. Yeah, that was an interesting time. As you said, it was just like, you know, everybody's Japan, Japan, Japan. And then like, holy cow, what's going on here?

When I think about the U.S. and its fiscal situation, it bothers me. The only thing that makes me feel better is when I think about Japan's fiscal situation. Are the debt levels in Japan sustainable?

I mean, Japan has the same issue as many developed countries, right? It's just a little bit further down the road. You know, its demographic pyramid changed a little bit earlier than it did in Europe or the US. But all developed governments are borrowing more money and running large budget deficits and increasingly have a large stock of public debt that is growing as a percentage of GDP. The good news for Japan is that its rates are extremely low.

And the vast majority of that debt is actually held by the central bank. It's not held by the private sector in Japan. Japan is a creditor nation. It doesn't run twin deficits. It has a large current account surplus. It's recycling capital and exporting it to the rest of the world. So it's not borrowing money in foreign currencies. It's not borrowing anything from the rest of the world. The debt is entirely owed

to its own people and held on the balance sheet of its central bank with exceedingly low interest rates. If you look at net debt in Japan, it's actually been flat. Net public debt in Japan has been flat for several years now. And if you look at net debt X, that held by the central bank, it's been going down steadily for several years now.

So I think the answer to your question, Greg, is yes, it is sustainable, so long as normal GDP growth and tax revenues are growing at a higher rate than real interest rates. Then I think you can sustain it for some time, or arguably indefinitely. And that, I think, is the inflection point that Japan faces.

So I don't worry about the public debt at all. I worry more about the terms of trade, Japan being a big importer of energy and commodities. That, I think, has been another reason behind the weakening of the yen in the last three or four years on top of the interest rate differential between U.S. rates and Japanese rates.

So I don't think the yen is going back to 100 or 90 anytime soon. I would expect it to be stronger, but I think the terms of trade have moved against Japan. It's actually running a trade deficit, but a large current account surplus because it has a big stock of overseas assets. I don't think Japan's trade position will improve particularly quickly, although I think this reshoring and friendshoring will help.

Because once that capacity is built, a lot of it's going to be exported back out of Japan again. That will actually rebuild a stock of capital. That will actually rebuild an industrial base in Japan that could increase demand for yen in the future as the merchandise is exported. But I'm not worried about public debt.

That isn't something that really figures into my mindset when I'm investing in Japanese equities at all. Yeah, those are two great points. It's not just the level of debt, it's the cost of service. And that's one of the things that Japan has going for it. Bring up a great point is that they have to import everything, energy, materials. And so that is definitely a risk. I wanted to ask you to maybe share a little bit of the story, the information around. I think this is absolutely fascinating, this...

I believe it was. It's originally a Texas company, 7-Eleven, who is now a Japanese company who is being approached by Circle K. That's how most listeners would know of the company and how that's kind of testing sort of the governance and the openness of Japan right now. I just think this is such a fascinating story.

I couldn't agree more, Greg. I think it's absolutely fascinating. And I think it's a really important litmus test for the market for corporate control in Japan. What you're referring to is a Canadian company called Couchetage, which is best known for the Circle K chain of convenience stores, which is attempting to acquire a Japanese company called Seven and I Holdings, which runs the 7-Eleven chain. And you're quite right, Greg. Um,

7-Eleven was originally a company from Texas that was acquired by this Japanese company in the 1990s.

So it's sort of come full circle. We now have a North American company. It's Canadian, but it's a North American company trying to acquire a Japanese convenience store chain. This, to me, is testament to how the relationship is changing between owners and managers of Japanese companies. Their shareholder registers are much more open. Japanese managements are being held much more accountable for the way that they

allocate capital the way that they produce returns. Asset managers are voting against senior management of Japanese companies and publishing those voting results. Activist investors are much more present in the Japanese market now than they were historically.

And Seven and I Holdings, which is the target in this case, had an approach last year from a large US activist investor, which they managed to fend off at the AGM, albeit under something of a cloud and with support for the activist proposals that were rather higher than the management would have liked. But they managed to bat it away only a year later to see a strategic buyer come in from Canada.

who are essentially saying the same thing, which is, look, you haven't created enough value. Your stock is too cheap. You're vulnerable and you need to do a better job. It's really the same coin, actually.

Explain or describe what a 7-Eleven is like in Japan. It is so different than what we kind of see at an American convenience store. It's like a cultural phenomenon, right? It is. 7-Eleven or convenience stores in general in Japan are deeply woven into the fabric of everyday life for Japanese citizens, whether they're living in rural areas and driving to the convenience store, whether they're working in downtown Tokyo and getting lunch at the convenience store.

You'll see a lot more private label merchandise in the stores in the form of food. So beverages, things like confectionery, desserts, very high percentage of in-house private label merchandise. Generally, I think you'll also find the stores are a lot brighter and cleaner than they are in the United States. I would much prefer to eat at a 7-Eleven in Japan than in the U.S. Yes.

I think the merchandise is generally of a much healthier nature than it is in the, you know, I think, I think you still have your sort of, you know, your Snickers bars and your Haribo gummies and things. The roller dog, you know, the hot dog that's perpetually spitting and cooking. That's right.

So yes, much higher foot traffic generally in Japan because it's more densely populated, higher turnover of merchandise, a lot more fresh food and a lot more private label. One of the reasons why Couchetard wants to acquire 7-Eleven is because the U.S. business is lagging behind. 7-Eleven in the U.S. isn't doing as well as it should be doing. It's losing market share to other players in the U.S. market.

It's made some acquisitions. They bought a business called Speedway from Marathon Petroleum, and that hasn't been integrated well into the 7-Eleven business. I think there's all sorts of reasons to believe that Seven and I Holdings isn't the best owner of these assets and that another industry player could do a better job. So I think this is a fascinating litmus test. Seven and I are obviously doing their best to throw CouchTard off.

and find reasons to deny this approach. They've actually just announced that they want to split the business into two parts, the convenience store part and the non-convenience store part, which is mostly a grocery supermarket and sort of superstore business, which is ironically exactly what the activist investor last year was asking them to do, which they said wasn't necessary. So they've

got egg all over their face with that. I think this has a decent chance of succeeding. It may have to go hostile because it sounds like Seven and I doesn't really want to sit down with CouchTard and have a constructive discussion. So they may have to go hostile. And at the right price, I think it has a decent chance of success. It's an open shareholder register. They've clearly got a vision that's more impressive than the current management that

Business as so all power to them. Yeah, thanks for that. It's interesting that talk about all this governance change and being open to foreign investors and you name it. It's just kind of funny that it may be ironic that 7-Eleven is the litmus test, right, of the entire job. You know, maybe it isn't, but it's definitely symbolic of it.

Yes, it is. I think the market for corporate control is changing very quickly in Japan. You've got a lot more activity by private equity in Japan now. KKR, Bain, Carlyle doing a lot more in Japan. And large companies willing to spin out non-core businesses and sell them to private equity. You've also got much more vibrant market for MBOs and LBOs. Succession, a family who can't find an obvious successor to the business and just want to take it private. Money.

more domestic M&A happening. And then I think increasingly this kind of very high profile inbound M&A, you know, from large foreign entities like CouchTard

I think the market for corporate control is much more liquid than it was historically. And it puts a lot more pressure on the management of Japanese companies to raise their game and create more value for shareholders, which has to be a good thing for equity prices overall. Yeah, I think that's right. I mean, if this can happen, this should be a floor, right? Because any other great company that's being poorly run will get acquired or PE will come in. So like this is pretty exciting, especially at these multiples, right? I mean, that's kind of the bull case for Japan.

Absolutely. So I think that's a really interesting element of raising value for Japanese companies.

The other, I think, Greg, is people like us being an agent of change ourselves, working with the management of Japanese companies, developing long-term partnerships with them. Our managing partner, Byron Gill, now sits on the board of Fujitsu as an independent director, and he heads up their compensation committee. And I don't think we would ever have imagined that something like that was possible otherwise.

seven or 10 years ago, maybe even five years ago, actually. So the amount of time we're spending now in the boardroom, you know, putting PowerPoint decks in front of boards and writing letters to CEOs and CFOs, it's profoundly different from what we were doing a decade ago. And I think the receptivity to that kind of engagement, that kind of interaction is way higher than it was

in the early years of my career in Japan. So that's another reason to believe that companies are going to improve capital allocation and raise the value of their businesses. I think that maybe speaks to something you bring to the table as well, right? As there's this new openness, I mean, it's still a great culture of respect, and you've been there for a long time. You speak...

fluent Japanese. You're not this cowboy kind of just flying in who doesn't understand the culture. You get it. It's kind of nice that you and Indus have that. I think we benefit from having a long presence in the market. You know, we've been doing this since the year 2000.

a number of stocks we've owned for 7, 10 or even longer than 10 years. And we've been able to develop a mutual respect, I think, in that partnership. We've got boots in the ground in Tokyo and also a team of analysts looking at Japanese stocks from outside who have more of a global perspective and I think can juxtapose a Japanese business versus a US or European business. So I think the symbiosis of all of that is quite powerful. But you're absolutely right. I think the kind of

balance sheet activism, the quick in and out, pay me a big special dividend, and then I'm gone. That doesn't resonate well in the boardrooms of Japanese companies. So the more constructive, thoughtful, operational activism is the kind of approach that's going to ultimately generate higher returns, I think, in Japan. But you've got to stay the course.

Sometimes you've got to learn to live with a lot of volatility and some setbacks, you know, from time to time. So duration matters. But ultimately, I think the pot of gold at the end of the rainbow is a large one because Japan is still so mispriced and so misunderstood.

All right. Well, let's close with a few things. So people who are interested in Japan, are there any books or anything that you would recommend or anything they can watch to kind of learn more about it? I've got two that I'd like to recommend. One is a very serious business book and the other is a little bit more lightweight or different, let's say. The

The business book is by a professor of Japanese business at UC San Diego, Ulrika Schade. And it's called The Business Reinvention of Japan. She's written many books on Japan, but this is her latest and I would argue the best book that she's written. And it really dives deep into two areas. I think one is how Japanese companies are so good at

adapting and changing. It touches a lot on the corporate governance changes that we've been discussing and how they adapt to changes in international markets. But it also talks a lot about the R&D engine and the intellectual property that Japanese companies have and how they're such critical players in often very niche segments or markets. You'll find Japanese companies with an 80% or 90% global market share

in somewhat obscure technology or business where the barrier to entry is extremely high. And if you take that little cog out of the machine, everything falls apart. So I think in this book, she does a really good job of describing the relevance of Japan in areas like the semiconductor value chain that we discussed earlier and how going forward, that's actually a really big opportunity for Japanese companies.

The second book is written by a fellow Brit. It's a guy called Chris Broad, and it's called Abroad in Japan. And he went to Japan in 2012, and a little bit like me, started life as an English teacher in Japan. He was actually teaching at a high school up in northern Japan. But he stayed on, and he's now got a very big YouTube channel with about 3 million subscribers, so you can watch it on YouTube. He's

His channel's called Abroad in Japan. And it's done this very humorous way, not too serious, but I think it's a really interesting window into life of someone who grew up in the West and is now living and working in Japan and all the kind of cultural idiosyncratic elements of life there that we discussed earlier. It's a very good read. It's very funny in places, a little bit vulgar in other places, but I think it's definitely worth reading. Not a business book. You're not going to learn a lot about Japanese business in it,

in this book. But yeah, it's quite a beach book. So I'd like to recommend that one as well. All right. Those are good. All right. Lightning round Godzilla or Japanese anime. My formative years were in England in the 1970s, Greg, where I grew up on a diet of American cartoons. You know, I was watching Wacky Races and the Flintstones and Deputy Dog and Scooby Doo. So I think if I'd been born 10 years later, I might have got into Japanese anime more. But my exposure to animated content was very much American. And I

I never really made the leap to anime. I also grew up loving King Kong, which I think is kind of the Western version of Godzilla in some ways. And of course, they battled each other in certain films, right? So I'm going to go with Godzilla over anime on that one. Yes. Sushi or yakitori? Again, I think this is the Englishman coming out in me, but, you know, cooked food over raw food probably most of the time.

Overcooked food. That's the English version. Overcooked food, right? That is changing at the margin. We should do another podcast about that. We're going to go with yakitori on that. Yakitori. All right. Because you're fluent in Japanese, why don't you close us out? Say goodbye or something in Japanese. Well, I'm going to say thank you for your attention today and goodbye. Thank you very much for listening to today's conversation. I look forward to working with you again. Okay.

All I know is sayonara. Sayonara is sort of informal way of saying goodbye. I said it in a slightly more formal business way. I'll do the more informal way. Sayonara. Japan is back. Shogun is back. It's the time. So, hey, Howard, thank you so much for your time today. Thank you, Greg. I really enjoyed it.

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