With global trade tensions sending shockwaves around the world, Japanese shares have not been immune from volatility. The threat of tariffs still hangs over its many export-led companies, but overall it has been a reasonable 12-month period for the sector, building on several years of recovery since late 2020 driven primarily by large ‘value’ stocks.
In contrast to ‘growth’ companies expected to increase earnings reliably or have exciting growth potential, ‘value’ companies are cheap and may not reflect their true worth until they come back into fashion.
Corporate governance is big in Japan
Primarily, the resurgence of value companies has been driven by corporate governance improvements driven by new regulation from the Tokyo Stock Exchange (TSE). One of the bolder measures requires companies to disclose capital efficiency improvement plans, particularly by those trading below 1x book value – a financial metric that determines how close a company’s shares trade to its net assets. A company that trades below book value implies it is priced below its break-up worth and seen by investors as a ‘value destroyer’. This has resulted in a flurry of buyback announcements from companies with excess cash.
Other measures are targeted at unwinding ‘cross holdings’ where Japanese businesses take stakes in one another. This strategy has historically been used by Japanese companies to support business relations, shield themselves from hostile takeovers and protect against uncertain, volatile markets. However, such activities have been criticised for locking up big blocks of shareholdings and being too aligned with management.
The strength seen in shares of Japanese banks and insurance companies reacting to the new corporate governance code explains much of the value style’s outperformance since 2020. Yet the broader effect is to reshape the business landscape with shareholder friendly policies such as better capital allocation becoming more widespread. Meanwhile, a more financially motivated shareholder base is pushing to effect change from the outside. While not all companies will wholeheartedly embrace this, the progress so far has deservedly caught the attention of global investors.
Deflation reversed
A further important trend has emerged in currency markets. Japan has finally engineered some inflation following years of negative interest rates and weak currency. After an extended period of falling prices, consumer behaviour is starting to change through a more orthodox scenario of rising wages and a rising cost of living. This has the potential to reinvigorate some areas of the domestic economy, and already rising interest rates have been beneficial for banks, allowing them to generate higher profits.
Yet with corporate governance reforms now widely factored into prices, and the yen no longer falling in currency markets, it may be other areas that stand to perform best going forward. Investors should also note the yen is notoriously volatile, and currency moves can negate or even overwhelm stock market returns in the short term.
Recent investment fund performance
Overall, here's how the two highly differentiated actively-managed funds in the Japan sector on our Preferred List got on over the past year, and over earlier periods, with commentary on each fund detailed below.
Past performance is not a reliable indicator of future returns. Figures are shown in £ on a % total return, bid to bid price basis with net income reinvested; Source: FE Analytics, data to 30/04/2025.
Japan investment trusts and funds to consider
Man GLG Japan CoreAlpha
This fund’s contrarian, 'value' driven approach continued to perform strongly early on in the review period, but was pegged back by the tariff volatility during April. It aims to beat its benchmark by investing in the shares of mainly larger Japanese equities that have fallen out of favour with the market, and in recent years this has meant exposure to companies and sectors more sensitive to the health of the economy, such as autos and financials.
Before the tariff disruption, market action played to the fund’s strengths with the value style outperforming. Some of the best-performing companies were those making strides in corporate governance improvement, and the fund was better placed than most to benefit.
Interestingly, the managers have become more interested in selected technology stocks recently following price falls, an area that has been largely absent from the managers’ radars for many years. However, the three main themes in the fund are the more familiar hunting grounds of autos, real estate and asset management.
The fund’s strict contrarian approach can result in volatile returns at times. 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 approach increases risk and makes performance versus the benchmark index more erratic than the average Japanese equity fund.
Baillie Gifford Japan Trust
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 at a faster rate than the market average over the longer term. 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 unlisted companies.
Having lagged the benchmark TOPIX index for three years in a row, which wasn’t a surprise given its more growth orientated style, performance stabilised over the past twelve months with a particularly strong period at the start of 2025.
According to manager Matthew Brett, the investment backdrop for the team’s style is beginning to improve, and his portfolio companies are delivering strong operational results. He believes the Trust is framing Japan through a unique lens by prioritising growth by supporting innovation and entrepreneurship, as well as aligning with structural trends for the long-term. Primarily this is through smaller and more domestically orientated companies rather than the large exports names common to most funds in the sector.
A lot of economically sensitive and internationally facing areas have enjoyed a strong tailwind in Japan, but the team suspect the environment going forward will be less favourable to these names, especially in a more adverse scenario around US tariffs.
Although returns have been disappointing over recent years, we retain conviction in the fund manager and approach for the long term. It’s only natural that fund managers with different styles and areas of focus will perform differently in different market conditions. The Trust is run by an experienced and well-resourced team with a clearly defined process. What’s more, the part of the market it invests in could now be attractive having trailed for some time. Although the focus is on growth areas such as internet businesses and smaller companies, the managers do consider balance sheet strength, which should help dampen the adverse effects of higher interest rates and help keep growth on track.
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