Being an activist investor in Japan — meaning ready to criticise company management — has never been easy.
For all the headlines generated from occasional activism by foreign hedge funds, the reality is that both domestic and overseas investors in Japanese stocks are wary of being labeled as troublemakers.
Most funds say they are frozen out of meetings with Japanese investment banks, brokerages and corporations once they gain a reputation for speaking out.
The dissent rate in electing company directors at annual general meetings in Japan was less than 8.5% among domestic and foreign investors alike in the last five years, the results of research by CLSA chief strategist Nicholas Smith indicate.
Japan’s media are equally cautious about reporting critically as they are largely beholden to corporations for advertising revenue and seemingly feel obliged to be cheerleaders for the nation’s industries.
So if not investors or the news media, who might be the sources of the criticism that Japanese companies should be hearing?
One group that tend to be outspoken are funds that focus on shorting stocks, or making a profit when an equity price falls.
Most of these funds operate in the United States and expanded their activities to Japanese shares, surfing the wave of enthusiasm for corporate governance reform whipped up by Abenomics.
At least three short-focused funds and one research firm specializing in critical reports have appeared in Japan in the past 18 months. The reaction to their appearance says much about the environment for bearish voices in the age of Abenomics.
Well Investments Research (WIR) reported in December, in unusual depth and detail, on the Tokyo company SMC Corp., the world’s biggest maker of pneumatic equipment used in factory automation.
The report alleges inappropriate accounting at SMC, which is due to release its financial statements for the last financial year on May 12.
SMC has let investors and analysts know that it intends to defend itself against the accusation when it releases its annual report, though this is almost five months after the WIR allegations.
Not all companies have the capacity or the need to respond to critical research but SMC is a blue chip with a market value close to US$20 billion.
The WIR report accuses SMC of reporting conflicting numbers in its disclosures to the regulators in Japan and abroad in what amounts to billions of US dollars. If the allegations prove true, SMC broke the law.
The WIR report contains other grouses about SMC. One is that the auditor Seiyo Audit Corp. is a tiny company that sits in the same building as subsidiaries of SMC.
Another is that Seiyo Audit had clients that later admitted to accounting fraud that the SMC auditor apparently missed. Other grouses are about ethics, opacity and potential conflicts of interest.
Right or wrong, the WIR report raises questions about compliance with the law – questions that merit discussion.
But SMC has broken its silence on the issue only to give two short statements to the Tokyo Stock Exchange, neither of which says much more than that the company believes it is innocent.
Appeals from analysts and investors for more clarity have been ignored.
What is lamentable is that SMC seems to feel no obligation to explain itself — the exact behavior that Japan’s corporate governance reforms are supposed to change.
Yet, it is not the fault of Abenomics policymakers if investors meant to benefit from corporate governance reform fail to speak up.
Meantime, the price of SMC stock rallied as investors targeted shares in cash-rich Japanese companies, including suppliers of automation equipment after the new administration in the United States indicated that there might be more investment in factories.
Investment banks that cover SMC, and which hope to do business with the company, mostly recommend that investors buy SMC stock even though they give the company a corporate governance score among the worst of all the companies they cover.
One of the few banks that at first didn’t rate SMC stock a “buy” was Credit Suisse.
But on Feb. 22 the bank issued a report saying SMC would present “explanations that allay concerns” and gave the gist of the expected explanation without identifying the source of its information. It then raised SMC stock to buy from neutral.
Perhaps the Credit Suisse analysis is correct, yet it seems to be based on selective disclosure by SMC and not information made available to the investing public.
In such an opaque investing environment, the believers keep the faith and the dissenters walk away, and neither course of action improves corporate governance.
One manager of a foreign fund that was granted a meeting with SMC officials said he was convinced by the company’s explanation. Asked why, the fund manager — who spoke off the record — said it was hard to envision real fraud in Japan.
Disclosures in recent years by Olympus, Toshiba, Dentsu, Fujifilm and others makes this perception clearly inaccurate.
But even if there were fraud at a Japanese company, the fund manager said he wouldn’t expect to win by shorting the stock because most domestic investors would rally for the company because they want the price to go up.
Here is where we come to a common perception in Japan that all short-focused funds are simply vultures that operate outside market norms and follow dubious principles. This attitude precludes serious consideration of short-fund research.
The chairman of the Securities and Exchange Surveillance Commission, Mitsuhiro Hasegawa, suggested in a recent interview with Nikkei that short-based funds should be investigated for potential illegal behavior.
Hasegawa’s comment could suggest he is concerned about short-fund activities rather than the companies they target — this despite the raft of recent evidence of fraud at such global, multibillion dollar Japanese multinationals as Toshiba and Olympus.
The question being, if the short funds are silenced, who will be left to investigate and ask the uncomfortable questions to SMC and other Japanese corporations?