Years of sluggish growth and perennial deflation have put many investors off investing in Japanese equities. The nation is home to some of the most well-known companies, particularly in the area of consumer electronics, but returns from the market have been poor since the extraordinary boom and subsequent bust of the 1980s.
When those in our 40s were still at school, Japanese companies were hugely indebted. After decades of global dominance and cheap credit on tap, Japanese corporates borrowed like there was no tomorrow, with corporate debt to GDP hitting 70% in the early 1990s. After the party came the hangover. Japan’s stock market lost 75% of its value by 2010.
There have been a number of ‘false dawns’ for Japanese equities over the ensuing years, but in 2020 the market finally flickered convincingly into life once more. The TOPIX index surged to all time high in US dollar terms and currently stands close to its peak in yen. The much-lauded Shinzo Abe, elected Prime Minister in 2012, stepped down for health reasons last year, but his policies to stimulate economic growth and reform Japan's markets look set to continue under his successor Yoshihide Suga.
Widely referred to as ‘Abenomics’, Abe’s ‘three-arrow’ approach of monetary easing, fiscal stimulus and structural reform have bolstered the Japanese economy and the market. Suga has made clear he will seek to continue to back the transformative reforms put in place, bringing reassuring stability. While expectations are still fairly low, Suga’s policies are pro-deregulation and pro-markets. He is keen on industry consolidation and reform, which could improve the profitability of Japanese companies.
Activism on the rise
As the market evolves the traditional view that Japanese corporations are set in their ways and do not sufficiently prioritise shareholder returns is being challenged. The number of ‘activist’ funds in Japan seeking to extract hidden value is on the rise, while private equity firms are also muscling in. They are attracted to balance sheets awash with cash – more than half of Japanese companies have net cash versus 10-20% in Western developed markets – and the ability of businesses to increase dividends and share buybacks, which could see greater value ascribed to shares.
Japanese stocks are therefore becoming interesting for investors seeking a secure and growing dividend income, and ideally some growth on top. The dividend yield exceeds that of the US market, but on average Japanese businesses are only paying out a third of profits as dividends, so there is significant room for pay-outs to grow. Investors might still be feeling disillusioned given lacklustre returns from previous decades, an aging population and the level of national debt, but they should not overlook the healthy and improving state of corporate Japan which could continue to quietly thrive if the anticipated post-Covid global economic bounce comes to pass.
There are also a lot of under-researched mid-cap companies in Japan, providing opportunity for active investors to find mispriced companies and generate extra returns. Notably, Japan is also home to a lesser-known emerging technology sector, much of which can be accessed via public markets rather than remaining privately held.
A brighter future
Japan has generally handled the Covid-19 crisis better than some developed markets in terms of both coronavirus cases and financial impact. By avoiding the full-scale lockdowns used by other countries, it has been able to limit economic damage and now looks well placed to benefit from the global recovery expected in 2021. The market contains more than others in cyclical sectors such as industrials and autos and is well placed to benefit from a revival in global trade and capital spending.
In particular, Japan could be poised to benefit from the strong recovery of its neighbour China. According to the International Monetary Fund, China is the only major economy that grew in 2020 and it is forecast to have some of the world's strongest economic growth in 2021. Resilience in production and consumption in China could benefit the earnings of the many Japanese businesses that sell into that market.
A number of US President Joe Biden’s policies could also be supportive to Japanese companies. For example, his environmental ambitions should benefit Japanese companies which have an edge in energy-saving manufacturing. However, the key factor for the market will be the extent and pace of recovery from the Covid crisis, as well as the scale of the monetary and fiscal stimulus globally.
Options for investing in Japan
There are many funds, exchange traded funds (ETFs) and investment trusts to choose from, ranging from generalist funds for ‘core’ exposure to more specialist approaches. Here is a selection taken from the best ideas of our Collectives Research Team. They are provided for your information but are not a guide to how you should invest. Before investing in any fund please read the relevant Key Investor Information Document or Key Information Document, and Prospectus.
Straight-forward, cheap exposure – passive options
Fidelity Index Japan Fund aims to track the performance of the MSCI Japan Net Total Return Index, which consists of large and mid-cap sized Japanese companies. For those preferring an ETF, Vanguard FTSE Japan UCITS ETF tracks over 500 large and mid-cap Japanese companies. In each case charges are highly competitive.
The ‘New Japan’ – Baillie Gifford Japan IT / Baillie Gifford Shin Nippon
Baillie Gifford Japan Investment Trust captures many of the growth areas available among Japanese corporates. The Trust’s managers believe the Japanese economy is undergoing structural transformation, with companies being run more efficiently and the service sector becoming larger and more dynamic. To capitalise, they target companies that enjoy sustainable competitive advantages in their respective industries and are capable of growing earnings and cash flows at a faster rate than the market average. The focus on growth results in a higher risk collection of holdings, which is exacerbated by gearing (borrowing to invest) of up to 20% and an ability to invest in nascent unlisted companies.
Its sister fund Baillie Gifford Shin Nippon has a more specific focus on innovative, disruptive business models representing the ‘New Japan’. The Trust’s portfolio will primarily consist of 40 to 80 listed companies, often smaller and earlier stage, held for the long term, and up to 10% is allowed in unlisted investments. There is a structural bias to the technology, healthcare, consumer service and industrials sectors.
Value-seeking and contrarian – Man GLG Japan Core Alpha
Buying into stocks or sectors where most investors fear to tread due to bad news or uncertainty can sometimes lead to impressive returns. Such investments are usually inexpensive with a lot of negative sentiment already priced in; if a turnaround does occur profits can be impressive. Man GLG Japan Core Alpha applies this approach to the Japanese market where some of the lowest valuations in developed markets can be found.
A strict contrarian approach can result in volatile returns. The team invest in stocks that have underperformed, sometimes to a significant degree, but things can worsen before they get better and this can detract from the fund’s performance. Combined with a high conviction approach of holding a relatively small number of stocks this increases risk and makes performance versus the benchmark index more erratic than more orthodox Japanese equity funds.
The fund’s high-conviction style can undergo periods of underperformance and is not suited to all market environments. In particular, it tends to struggle in relative terms versus its peers and benchmark in a market that prioritises certainty of earnings from companies rather than cheap valuations – as has been the case in recent years. However, we believe it is worthy of consideration by those looking for exposure to especially out-of-favour Japanese firms and are willing to believe market sentiment will shift decisively towards them.
Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.
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