The Exchanges

Q There's a curious part of that where you're understanding how this is an insider's game as you're on the ground. I wouldn't think that would necessarily lend itself to, oh, we're going to invest in these companies as an outsider. What was that thought process as you became a sell-side analyst?

A I realized how markets were organized in Japan so you could figure out who the winners were going to be. Winners are chosen in Japan. The competition is managed. I had the good fortune of starting my career in the telecom sector. What made that sector different is at the time I started, There were really only four companies, an international company, KDD, a domestic company, NTT, their recently spun out cellular business, Docomo, and a third new market entrant that was introduced to finally mix up and create competition. And in this, the rules of competition were very familiar to me, and I understood how this market would be organized, and it made it very easy for me to model and be helpful to foreign investors thinking about allocating capital to Japan.

AI assessment note: “I realized how markets were organized in Japan so you could figure out who the winners”

Q How does the regulatory body or regulatory bodies go about some type of enforcement of the stewardship code?

A Japan is different. They make domestic investors disclose how they're voting. They embarrass them. It takes Miti to embarrass the managers of these companies They have to threaten unsolicited takeover bids. It takes the TSE to literally publish a list of companies that are not publishing a cost of capital and proof that the management team is managing the business with a cost of capital mindset. So there is no immediate one center to this. It is a collaboration between various parts, and you'd think that it would be the investors that grab this bull and take it by the horns. But they wait until all the other institutional stakeholders and participants and regulators give them the green light before they take action.

AI assessment note: “They make domestic investors disclose how they're voting. They embarrass them.”

Q Why don't you take me back to what got you interested in Japan?

A Well, it was my grandfather. My grandfather, an industrialist in Cincinnati, was invited to Japan in the late sixties to help rebuild the Japanese glass and steel industries. He made high temperature industrial bricks, and there were only two companies in the world that could produce bricks that could go to a 1400 degrees. And with that, he made the four day trip to Japan in 1968. And after that, he would go almost every other year and pass through Washington, D.C., where I grew up. And tell me stories about the other side of the world. And being a white guy from the Midwest, he made Japan seem very interesting to me by making up interesting stories about how it was polite to burp at the dinner table. He was a gardener. He was a self-made engineer, and he found many levels at which he communicated with Japanese people well beyond the language. So that made a strong impression on me. Ultimately, it's been a lifelong constructive obsession. My entire professional career has been thinking about Japan.

AI assessment note: “Well, it was my grandfather. My grandfather, an industrialist in Cincinnati”

Q Which two people have had the biggest impact on your professional life?

A I first have to say my wife, and the answer there is coming home from a day at work, she looked at me and said, did you have one of those days? And I said, I had one of those days. And she said, do you really think it's time for you to do something on your own? I said, it's time. She said, you should do it, and I'm giving you 18 months to do it. If you're going to do this, I want you to give it your all. I want you to have an end point, and I don't want it to always be around the corner. So she put a time horizon on my ambition, and I had to show results. That's a really important partnership that helps bring great clarity to something as hard as starting your own company. I think the second is a mentor in Japan. Wakabara-san. Wakabara-san is a titan intellectually, an engineer. When I first got to Japan, almost as a stowaway, found my way into an investment bank. I was the only foreigner in the investment floor of the research group. And nobody thought a foreigner could bring any informational advantage in the Japanese equity market. And I was seated purposefully by the head of research next to Wakabara-san, who was the axe on Japanese semiconductor stocks, famous for three days of being awake and getting information. He was truly a titan of the brokerage industry, informationally, intellectually, That's when I realized, oh my God, that's my pace car. That's the person that if…

AI assessment note: “I first have to say my wife... I think the second is a mentor in Japan.”

Q What led to your transition to finding condomate?

A So I told you about my five-year cycles, and I'd been through three of them at GMO. Learn how to put together a portfolio. Learn how to think about that in the context of macro events. Finally, learn how to take a portfolio that I'd inherited that had ultimately 77 stocks and turn that into a high-conviction portfolio of just 13 names. How to really take constructive risk. And when I mastered those three five-year cycles, I saw on the horizon that Japan was finally waking up from a thirty-year slumber, that a governance breeze was blowing, and that true to form, what Japan didn't understand, and that I could arbitrage into this market, was accountability and governance. But Konami Capital was really the distillation of everything I'd learned at GMO, and why I wanted to purpose-build a company specifically To go after a part of the Japanese market that was largely misunderstood, neglected, too cheap for a value manager to ignore.

AI assessment note: “Konami Capital was really the distillation of everything I'd learned at GMO”

Q What's happened over the last seven years, and particularly recently, that has you particularly excited that we're on the cusp of a significant change in governance?

A So there's another false start that happened in I'd be remiss to skip over that. It was another false dawn. That was the BOJ doing a hostile takeover of the Japanese bond market. They drove the final push on the JGB yield curve, dragging it through zero. When I was at Brookings, we debated whether Japan could go through zero, and boy, did it go through zero. What that meant is GPIF was flushed out of the JGB market and was pushed into the equity market. It was thought that just by making debt super cheap for Japanese managers, they would access the semi-permanent capital bonds, and the story would write itself. Animal spirits would be unleashed. It didn't happen. It didn't happen because the voices of shareholders were still too muted to drive that balance sheet Reflation of replacing high cost equity with cheaper debt. So that was a failure. So fast forward to 2019, 2020, where thankfully Konami Capital has been invited into the study groups at Miti, into the study groups at the FSA, and they say, how can we finally get the voice of minority interest shareholders to change the capital makeup of the balance sheet? And we said it's a market for control. Without a market for control, everything is fine words without fine deeds. Until a management team suffers an unsolicited bid from someone who will run the assets better, you won't get the type of change you're looking for. Japan…

AI assessment note: “I took METI officials to Harvard Law School... saw the light bulb go off”

Q everything from portfolio accounting to reporting to reconciliation, trading, compliance, and more. In the AI era, asset and wealth management firms moving to Ridgeline gain a decided advantage. That's why customers call it miraculous, game-changing, and an awakening. If that's not how you would describe your investment management tech, request a demo at ridgeline.ai. And now back to the show. How do you think about what works in generating returns?

A Value works, but you have to be very careful. Value works for two reasons. One, in Japan, this has been a growth-starved economy for a long time. When there is a growth company, it tends to get overvalued. Traditionally, the boundaries of growth are hit and the company disappoints. So value works because you start with low expectations, And any positive surprise is asymmetric return. The other thing about Japan is it's easier for me to love what the herd hates, that I find it easy to embrace and understand why the collective wisdom of the market in Japan is often wrong because they do not understand when leadership is embarking upon a journey of change. When I first started investing in Hitachi, one of Japan's large cap darlings, It was 2008. The share price was 236 yen. A new manager came in and sat in front of me, Nakanish-san, and he said, I've read through the notes. You've kindly met with Hitachi for five years, and every year you've given us a laundry list of things we need to do. I've read it. I'm here to tell you that we have failed. Our share price is back to 1973 levels. I'm going to do what you've told us to do. The meeting lasted 30 minutes. And in that 30 minutes, I realized that this company was serious about change. We backstopped a follow-on offering, and the stock has been on a tear for the last 1213 years. Japanese people laughed at me. They were horrified. So…

AI assessment note: “Value works, but you have to be very careful. Value works for two reasons.”

Q How do you know looking at companies and assessing the market that the insiders have decided that it doesn't work?

A You get invited into the control room. And I didn't know it at the time, but at GMO, I did probably 450 meetings in Boston a year in Japanese. And the reason the carpet was worn out to our meeting room was GMO had both my fundamental portfolio and then a quant team that owned anywhere from 125 names. So every Japanese company that saw GMO show up in the shareholder role thought I was their shareholder. I made it a policy. If someone wants to come and talk to me for an hour about their business, I would say yes. And out of this came a relationship with the C-suite of the top 700 companies in Japan. What I didn't know at the time is the quiet person that shepherds the C-suite into my meeting room are from the trust banks. And the trust banks are quietly taking notes on who is engaging with Japanese companies and always asking them to make a better peanut butter and jelly sandwich, but doing it in a way that's constructive. I didn't realize that I was building a track record and a following in Japan. With great humility, what happened is a lot of these stewards of the companies, primarily from Sumitomo Mitsui Trust Bank, ended up becoming the insiders in the GPIF, the Government Pension Investment Fund in Japan. These guys were the drivers of the governance upgrade in Japan. I told you that the cost of equity and the equity risk premium Is a big ultimate mover of the Japanese equi…

AI assessment note: “You get invited into the control room.”

Q So I'd love to turn to how you were taking advantage of this. So let's start with Konami. The name, what does it mean?

A So Konami is the linchpin. It's the linchpin in a fan. So a fan in Japan is the symbol of prosperity. And the more the fan is opened, the The more prosperity is being shared. And this is a well-understood symbol in Japan. And by being the kaname, the pin, the whalebone that literally holds this fan together, our role is to protect the cost of equity. We think the cost of equity is the kaname of the economy. With the proper protection of the cost of equity central to every balance sheet, you get capital to start flowing again. So this message is the reason we think in our dialogue and our engagement with companies comes with A high degree of spreading prosperity. Joint value creation.

AI assessment note: “Konami is the linchpin. It's the linchpin in a fan.”

Q So the corporate governance reform story has come in and out of favor in Japan, at least for the last 20 years. And I'd love you to take me through what didn't work in the past, and why might that work this time around?

A I like to preface the governance conversation as a proximate cause, but the ultimate cause in Japan is the cost of equity and the equity risk premium. Up until Multiples were high. The bubble was still deflating. Ultimately, it wasn't until the final banking crisis and the cleanup in 2003 and 2005 that the overall market derated. And that's the first time you heard talk of governance. It was because for the first time management teams were under pressure to deliver on the cost of equity. So the first time happened in 2005 as Japan was finally emerging From a two decade long period of overvaluation and a workout of the Japanese banking system. 20% of Japan's GDP was run through the Japanese banking system between 1997 and 2003. And they did that without a revolution. You could only do that in Japan. So the first governance phase happened in 2005 when the equity risk premium exerted itself. But another thing was happening at the same time, and that is that the Nikkei and Topix was on 7000. Today, we've gone back to just under 40,000. The Nikkei and Topix was on its knees. The reason for that was that the Japanese pension complex was undergoing a change. What happened is corporate entities that were seeded the overall pension obligation We're putting these obligations back to the government, and they had to do it through the market. So you had this huge force selling as a mark to …

AI assessment note: “So the first governance phase happened in 2005 when the equity risk premium exerted itself.”

Q When you're assessing that management's willingness to improve the stock price through those meetings, and you've got these two extreme buckets of yes, please help us and go away. How much does the understanding of the local culture help you interpret what that message is?

A It's hard work, and even Japanese people miss it at times. It's not an overstatement to say that sometimes not even Japanese people know what Japanese people are saying. And sometimes my job is to pretend I don't understand what they're saying. This is the dynamic, and I'll walk you through a few examples. We hear a company that understands that they've got a good business, It's not a run and hide, try and dodge taxes type of business, but maybe they're a slow moving company in a slow moving industry, and they've just never really thought about shareholder return. They've got a big anchor shareholder that owns 35%, a negative control element, and they know that basically they don't have to listen to shareholders, so they've gotten in the bad habit of not doing it. This type of company has, in the process of ignoring shareholders, Has also ignored animal spirits and aggression. And when we show up, we say, do you realize that there's a shift happening in your industry? You've got 25% global market share. Now is the time for aggression. It might sound strange to you, but we're not here to ask you for a big buyback and a large dividend. We want you to go all in on investing in next generation fuels in your Himeji plant. We want you to capture Market share in ammonia, methanol, hydrogen, next generation fuels in the shipping industry. Huh, we've never thought about that, says the c…

AI assessment note: “It's hard work, and even Japanese people miss it at times.”

Q In those first bunch of years where you were on the south side, what were some of those other insights that you found and were able to share?

A I believe in five-year cycles, and my career in Japan has at first been figure out the language, figure out how to basically be engaging and make friends and just become part of the group. It's a group tribal society, so you have to figure out how to get inside. So that first five years was spending time and being part of the KO rowing team and living in the rowing dorm and learning how to become bilingual, bicultural, and code switch, learning how to be Japanese, if you will. And then when I transitioned to the professional career, what I learned is that they didn't understand valuation, largely in the market, and that I was able to provide that. My next bridge too far was when I thought, well, people really want my opinion. The role of an investment bank, especially a research analyst, is to tell people when to buy and sell. I tried to write sell notes, and that's when I learned that the role of research in Japan Is to be a cheerleader, nothing more, nothing less. That people didn't want your opinion, they wanted stocks to go up. I started writing sell notes, drafts of them, and those drafts would make it on the desks of certain powerful people, and I'd be told that if you really valued your opinion, you might think about moving to the buy side. Ultimately, that was a great career move, and that was the end of my sell side experience.

AI assessment note: “what I learned is that they didn't understand valuation, largely in the market”

Q How did you decide how many companies to own in the portfolio?

A That's been an evolutionary step, and one confession is in our five-year existence, We started as an equally weighted value portfolio and thought that the factor would drive the return, and in our mind, where quality meets value. Japan has shown that it compounds at about 12%. In the first year or two, the best companies in our portfolio with open shareholder roles got bought. We enjoyed the market for control expressing itself in our portfolio, and five companies got bids, and we thought, hurrah, we've bottled lightning. What we didn't realize is that the remainder of our portfolio were the tough walnuts. The easy nuts had been cracked. So through that, we had to parse and let go of the nuts that we could never crack and then find the ones that we could. And then we had to refresh using our output to find higher and better uses of capital. That was a lesson learned in 2021, 2022 through covid. And thankfully, I was able to bring this highly talented team on From Japan, a key addition was Nao Makino. I found him at Columbia Business School. Young, hard-charging, veteran of markets at a young age of 33, and between us, we jokingly call ourselves Batman and Robin. He helps me understand the fact pattern I see and translate that culturally into conviction. So today, our portfolio is really 15 names, with the top five or six names representing 50% of our portfolio. That's where our…

AI assessment note: “So today, our portfolio is really 15 names, with the top five or six”

Q How does the rise in interest rates, cost of debt, and increased cost of equity affect the outcomes of these businesses?

A The second risk is a stronger yen. The yen is obviously the first derivative of interest rate differentials, and perhaps we'll talk about the carry trade and some of the convulsions we've seen recently. Our portfolio is built for these events. What I mean by that is the yen carry trade and the yen strengthening is something we're prepared for. We don't have a portfolio predicated solely upon weak yen. We think that risk is primarily high valuation in almost any environment, whether it's strong yen, weak yen, slow economy, higher interest rates. We've incorporated all that history in our screen and our ten-year look back, and all of our companies have survived all of these exogenous shocks. So our portfolio is built for even things like the normalization of Japanese interest rates. We think it's positive because what it does is it finally puts a price tag On the cost of debt, and it means that what was being offered for free, you're now going to have to pay for. And anytime you put a price tag on decision making, people start to act. So we think that rising interest rates in Japan is just the sign of the Japanese economy finally normalizing.

AI assessment note: “We think it's positive because what it does is it finally puts a price tag”