Tickets for the Japan rollercoaster are getting cheaper, says Darius McDermott, managing director, FundCalibre
Not only did Japanese equities fall 5 per cent (at a time when global equities returned 23 per cent)*, but we also saw change from a political perspective as Shinzo Abe’s successor, Yoshihide Suga, lasted just one year in the role before Fumio Kishida took over in October.
They often say it is the hope that kills and investing in Japan is no exception. The Japanese were hailed as one of the ‘masters of modern capitalism’ in the 1980s and, on 29 December 1989, the Nikkei 225 stood at a record high of 38,957. It didn’t exceed 30,000 again until February 2021**.
War in Ukraine has heightened volatility in markets. And, although Japan has little exposure to the area, its economy and corporate profits are sensitive to global growth and commodity prices, both of which have been significantly impacted by the crisis.
But there is room for optimism, even for a market as uncertain as Japan. In fact, I’d argue that, alongside the UK, it is one of the few areas where there might be significant valuation opportunities.
Matthews Asia portfolio manager Shuntaro Takeuchi says Japanese companies may be on the verge of delivering a combination of attractive valuations and growth opportunities to investors.
He says Japan’s earnings growth and general improvements in cash flow generation – courtesy of innovation, productivity and capital efficiencies – have not been reflected in valuations compared with other regions in the past decade. He says growth in many other regions has been supported by multiple expansion, while Japan’s has come through earnings performance. The average P/B ratio over the past 10 years in Europe was 1.8x, in Asia ex Japan it was 1.5x, in China it was 1.6x, and in Japan it was 1.3x***. This has scope to change in an environment of inflation and rising rates – due to downward pressure on multiples as investors search for safer, high yielding assets. The fact Japan’s valuations are cheaper limits that pressure to some degree.
A sharp depreciation of the yen may also have made it a challenging period for foreign investors in Japan. However, figures show Japanese equities have been relatively resilient in local currency terms (falling just 5 per cent in the first four months of this year)****.
Schroders equities specialist Simon Keane says local currency terms give a picture of how the underlying market has performed as it “strips out the impact of exchange rate moves that non-yen investors feel”****. He adds that Japan’s resilience versus some other developed markets perhaps partly reflects hopes that a lower yen will boost Japan’s export-heavy economy.
There are also a couple of longer-term tailwinds for investors to consider. Firstly, the reforms in the past decade, like the Stewardship Code and Corporate Governance Code, which mean Japan now has some of the strongest protections for shareholders globally. These corporate changes also mean Japanese boards are more likely to pay a dividend based on a percentage of profits – a reality with the large cash sums on their balance sheets.
There is also the wider adoption of technology, with Japan’s leading manufacturing companies potentially experiencing significant growth as the increases in computing power create opportunities in automation. In fact, the major index constituents are increasingly technology-focused and Japan’s manufacturing prowess means that roughly half of the major global robotics companies are listed in Japan.
Japan’s new Digital Agency, launched at the start of September 2021, could also play a major role. The lack of digitalisation in government services for the public has caused problems during the pandemic, for example, delaying the handling of applications for financial support and slowing the transmission of medical data^. Many schools also struggled to switch to online teaching. The use of digital technologies more extensively has the potential to contribute to economic growth through improved productivity across both the public and the private sectors.
Funds and trusts to consider
Baillie Gifford Shin Nippon
Shin Nippon means ‘new Japan’ and this trust focuses on emerging or disrupted sectors where manager Praveen Kumar sees innovative growth opportunities that he believes offer above-average growth prospects. Recent performance has suffered, but the trust has produced exceptional long-term returns.
AXA Framlington Japan
AXA Framlington Japan invests in Japanese companies of varying sizes but tends to have a slight bias towards smaller companies. The manager looks firms with long-term growth prospects which are independent of short-term news flow or what is going on in the wider economy. The portfolio usually contains around 100 holdings which limits the impact of any one stock on the portfolio.
FSSA Japan Focus
FSSA Japan Focus is a high conviction fund investing predominantly in large and medium-sized Japanese companies, with a heavy emphasis on quality. The team has regular discussions on potential new secular themes and new ideas are generated through more than 300 company meetings a year. Companies which are deemed good enough make it onto the fund’s 120-strong watchlist.
Investing in Japan – pros and Cons
• Markets look cheap, aided by weakened yen
• World leaders in robotics and automation
• Improving corporate governance
• Businesses have lots of cash on their balance sheets (potential for greater dividend payments)
• Stagnant shrinking economy
• Economy weighed down by massive government debt and poor demographics
• Has stayed cheap for so long
*Source: FE fundinfo, total returns in sterling, MSCI World and Nikkei 225, 1 January 2021 to 31 December 2021
**Source: Baillie Gifford, September 2021
***Source: Matthews Asia – The Return of Japan – March 2022
****Source: Schroders – What does a weaker yen mean for investors in Japan? May 2022
^Source: T. Rowe Price – 2022 Outlook – Prospects for Japan look bright
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’s views are his own and do not constitute financial advice.
This article was first published in the July/August 2022 issue of Professional Paraplanner.
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