Japan’s importance and relevance as a global investment powerhouse are often overlooked, perhaps due to the stereotypical Japanese cultural traits of being quiet, shy, and reserved. Given it’s the 3rd biggest economy in the world, ranked 11th in terms of population and has significant cash reserves, no economy in the world is better equipped to deal with the current market predicament, and well beyond it than Japan is. It’s a very exciting point in time for the Land of the Rising Sun.
Japan’s increasing investment in the venture capital industry since 2014 has been nothing short of staggering. The Japanese venture capital market has grown from 300M USD in 2014 to 2.1 Billion USD in 2019. A sevenfold increase.
In 2019 both the Softbank and Mitsubishi Groups were ranked in the top 10 globally for venture capital investment. While Japan has its detractors, due to its demographics and a perceived lack of growth, it’s hard to look past the mountain of cash available to corporates in Japan, in addition to a clear change in attitude towards higher risk start-up investment.
For the most part, Japanese investor’s proclivity is towards smaller deals, but many of them. This reduces their risk in a portfolio of start-up investments.
Around 50% of start-ups make positive returns on an annual basis. Given that the top 25% of VC funds have had an annual return ranging from 15% to 27% over the past 10 years (according to research from Cambridge Associates). ROE of that magnitude is almost impossible to ignore. So why is so much Japanese capital flowing into the venture capital industry? We believe there are three main reasons
1) Japanese corporations need to invest in innovation to future proof their businesses
2) Masayoshi Son has already proved that you can earn ludicrous money by investing in the right start-up and
3) Japanese companies need to put some of their hard-earned cash to work, something they’ve been reluctant to do up to this point (times are changing).
Future-proofing Japan Inc
During the era of walkmans, Discmans and even mini-disc players, Sony, Panasonic & Co. had enjoyed decades of profit and Japan seemed to have the entire portable audio market sewn up. Apple had no right to later dominate this market but, as we know, that’s exactly what happened. It’s a great case study but none the less a bitter pill to swallow for Sony when you consider they had invested heavily in copyright ownership for both the music and movie industry, already had a world renowned brand name, manufacturing plants to mass-produce portable audio devices, and a global distribution network in consumer electronics. Somehow, Sony let the next generation of portable audio devices slip through their fingers. Perhaps Sony was too big? Perhaps Sony was too bureaucratic? Or… perhaps Sony was happy with the status quo and didn’t want to entertain the idea of a disruptive technology coming to market which would destroy decades of market dominance?
None the less, it looks like Sony have learned their lesson and has since launched the Sony Innovation Fund, no doubt realizing that in the business they’re in, changes at breakneck speed, and investing in innovation is paramount to staying relevant in an ever-evolving industry.
The trend is your friend and so is Masayoshi Son
Masayoshi Son (Son) has proved that investing in the right start-ups can lead to significant returns. While it might otherwise be a challenge to change the mind of a very conservative Japanese boardroom, Son has proved to the rest of Japan Inc. that the returns are there for Japanese investors. Albeit requiring a combination of smart investment and some luck.
Venture Capital is now a real alternative for Japanese corporate investment and Son has brought it into the limelight. It’s worth noting here that other traditionally more reliable asset classes are increasingly showing diminishing returns. While it’s nice to romanticize about Japanese corporations suddenly taking on more risk in the VC market, if they don’t, it will be to their detriment.
In 1989 The Nikkei reached an all-time high of 38,915, 30 years later, it’s sitting at around 22,000, and considering there has been significant inflation since that time, there is plenty of room for Japan to get back to its all-time lofty highs. Most other Asian markets and the US hit all-time highs in recent memory while Japan has somewhat languished during the same period. The solution to this problem is very easy for Japanese corporations to remedy if they’re not going to make their stocks more attractive by paying higher dividends, they need to invest.
Japanese corporations pay about 40% of their profits back to shareholders, compared to the US where that figure is significantly higher, i.e. 70%. The amount of cash sitting in Japanese banks stands at well north of ¥500 trillion, i.e. larger than most countries’ GDP. When Prime Minister Abe came to power in 2013 he was insistent this cash hoarding could no longer stand, yet here we are, 7 years later with record cash reserves and no sign of this trend abating.
While many Japanese businesses went to the wall post-bubble era, due to lack of debt availability, it seems as though, since that time, the pendulum has swung in the extreme opposite direction. Japanese corporate management by their own admission has stated that they need to invest more capital.
By our estimates, there will be ample opportunity in the venture capital market with less competition in the coming years. This suits the Japanese business model of having the cash reserves to pull the trigger when the appropriate opportunity presents itself. After decades of accumulating cash reserves, now would be a great time for Japanese corporations to invest, generating higher profits, and repay shareholders’ faith.