Japan has several long-term social and economic challenges, and looking for companies that seek to address these can be a way to find firms with good fundamentals, writes Satoshi Marui from SuMi TRUST.  Japan faces many long-standing social and business challenges, such as its ageing population, persistent wage stagnation and ossified corporate practices. These problems are endemic to Japan. Generally, they make foreign investors cautious about committing their money. However, if rightly understood, these issues can present a unique opportunity for investors. Why not construct an investment strategy around buying companies that can showcase their economic health through their willingness to tackle these challenges? Not only is this willingness indicative of strong financials, but this attitude also affords the investor insight into the managerial ethos. So often, companies prepared to sacrifice short-term economic gain – by, say, paying salaries above the market rate – have the kind of long-term vision that enables consistent strong performance. Companies in the service sector that provide essential services for Japanese people are often the best positioned to combat these social challenges. This is because these companies have their finger on the pulse of Japan’s social landscape. Issues like ageing populations and stagnant wages are systemic and have plagued Japan for many years. Whilst individual businesses cannot hope to remedy these issues single-handedly, if a company can successfully derive a competitive advantage from tackling these issues, this suggests strong management. Take wages as an example. Wage growth in the Japanese economy is sluggish; real wages have remained essentially unchanged for over two decades1. This is partly a result of Japan’s corporate culture. For example, Japanese companies have traditionally prized a seniority system. It is rare to pay younger employees, even if they are excellent, higher salaries than senior employees, because of concern for existing older employees. If a company can invest in human capital and offer progressive payment packages, it can outshine its rivals and capture market share. The ability to sustain higher wages is a strong indicator of a well-run business and future growth. Businesses in the childcare services provision market demonstrate this principle's value. Unlike in Europe and the US, these employers sometimes offer starting salaries to rival those of big Japanese banks. In addition, these companies are choosing to offer competitive remuneration to attract employees in an increasingly tightening labour market. Paying well for good talent is a value commonly held in high esteem by successful businesses. Prime Minister Kishida’s recent pledge to fight against Japan’s declining birth rate, including investment in childcare services, serves as a significant tailwind for the industry. This is because the industry stands at a desirable intersection: the difficulties stemming from an ageing population are omnipresent, so government support for childcare services will surely rise. Small caps willing to provide specialist services to an expanding market with few direct competitors also stand to grow. As Japan’s population continues to age rapidly – one in four people will be ‘elderly’ by 2025 – there are an increasing number of people living with Parkinson’s. Businesses that fit the niche of offering palliative care for those suffering from Parkinson’s are set to see dramatic growth; they are poised to benefit from increased demand for their services. This makes them an attractive investment proposition whilst providing a much-needed service with real societal value. Companies working to address Japan’s social issues are not confined to those providing care products or services. You can also find these companies in the tech sector, where some forward-looking businesses offer generous compensation to their employees. Businesses that pay well often cultivate loyalty amongst their workforce, which is a valuable asset in any growth strategy. So, one way to think about Japan is that its society and economy face many challenges. A sound investment strategy is to find strong and socially beneficial companies by looking at the firms addressing some of these challenges. If a company can sustainably pay a higher wage to its staff, it will have a significant advantage in a market where wages are low and stagnant. Despite an often gloomy outlook on Japan’s medium-to-long term future, as the ageing population bites and inflation negates meagre wage growth, there are many opportunities to be had by companies with the foresight to turn this situation to their advantage. *Satoshi Marui is the chief portfolio manager of the SuMi TRUST Japan Small Cap Fund and head of the SuMi TRUST Small Cap Strategy © 2023 funds global asia