Buyback Heaven

**Edward Chancellor** (0:08)
Hello, this is Edward Chancellor and welcome to another episode of The Capital Cycle Podcast. I have with me Justin Hill, who's a portfolio manager for Asia Pacific with Marathon Asset Management. Welcome, Justin.

**Justin Hill** (0:21)
Thanks, Eddie. Good to be here.

**Edward Chancellor** (0:22)
So, Justin, your recent contribution to the Global Investment Review is called Buyback Heaven.
It's about the prospects for share rate purchases in Japan. Marathon has always been a keen exponent of buybacks at the right price, I should add. And to set the scene, you start your latest contribution with a comment from Warren Buffett, which actually was in the 1984 Berkshire Hathaway annual report.

**Justin Hill** (0:53)
Yeah, that's right. And he does talk a lot about buybacks, but it's not a kind of blanket endorsement. I was thinking, if you look at this quotation, he's really putting three qualifiers on the desirability of buybacks. So I'll read you the quotation. What he's saying is, when companies have outstanding businesses and comfortable financial positions, and they find that their shares are selling far below intrinsic value in the marketplace, no alternative action can benefit shareholders as surely as repurchases.

**Edward Chancellor** (1:22)
It's hard to argue with that. And what's the recent story about Japan in this respect? Historically, as you know, Japanese managements have often excelled at running their businesses, but their capital allocation skills have left something to be desired. But as you write here, and as former contributions to global investments reviews by your colleagues have pointed out, that is changing.

**Justin Hill** (1:50)
Yes, so if we go back to 2015, the Corporate Governance Code was published for the first time in Japan.
And if you want to put your finger on a specific driver, in the last few years, in 2023, the Tokyo Stock Exchange launched its campaign, which was aimed to encourage companies to think a bit harder about their cost of capital and how the businesses are structured. They called this Action to Implement Management that is Conscious of Cost of Capital and Stock Price. In a nutshell, that was, as you say, basically what it boiled down to was, look, if your shares are trading at below book value, please can you explain why and also explain what you're going to do about it.

**Edward Chancellor** (2:34)
And the Tokyo Stock Exchange's timing with this measure was good, you say?

**Justin Hill** (2:40)
It was good because the global economy was coming out of the COVID period.
So we had, especially in Japan, the first signs of inflation for many years, interest rate expectations started to pick up. As a result, corporate management in Japan were already starting to think about capital policies in particular. As you mentioned, we've talked about this in previous Global Investment Reviews, but historically in Japan, shareholders had been tended to be placed down towards the bottom end of the hierarchy of corporate stakeholders.

**Edward Chancellor** (3:13)
And those stakeholders would be employees, customers, suppliers, bankers.

**Justin Hill** (3:21)
And obviously on the employees' side, the whole job-for-life culture was very much part of that.

**Edward Chancellor** (3:27)
I remember visiting one Japanese company and it referred to them as the Five Joys, but the shareholder was definitely the fifth and last joy in that list.

**Justin Hill** (3:35)
That's pretty much right. But one aspect that has been changing is that the profile of share ownership in Listed Japan has changed quite a bit over the last 20 years.
And you've had this steady movement away from a predominance of cross-share holdings towards financial investors, and in particular, foreign investors who have slowly but surely been putting more pressure on corporate Japan to change.

**Edward Chancellor** (4:00)
And the apparent end of the deflationary era added further impetus. So you write the stock exchange was pushing on a partly open door when they published their guidance. And you then say that this intervention by the stock exchange resulted in almost immediate pick up in share repurchases.

**Justin Hill** (4:22)
That's right. So one of the things to look at is buy back plan announcements, and the extent of those announcements is a leading indicator of what's actually going to happen in the market. And those really took off in late 23, early 2024, and are running at a rate that's two to three times what we were seeing before the Tokyo Stock Exchange came out with its pronouncements. So there's been a clear kind of inflection on that from that point of view.

**Edward Chancellor** (4:47)
And it's pretty obvious buybacks are particularly advantageous for companies in Japan that are sitting on large piles of cash.

**Justin Hill** (4:56)
Yes, absolutely. So their cash pile in the last few years will have been earning almost nothing. Maybe you can get 0.4% on a one-year deposit today, and that's against an inflation rate that's running close to 3%.