The Japanese market could be in for a resurgence and investors may want to rethink their allocation to the country, experts have said.
Japanese equities have been out of favour since the asset price bubble in the late 1980s and early 1990s.
Since then, Japan has been struggling with an ageing population, falling inflation and stagnating economic growth. As a result, the MSCI Japan index has trailed the MSCI World by 24 percentage points over 10 years.
David Cadwallader, investment manager at RBC Brewin Dolphin, said: “Japanese equities often provoke very mixed reactions amongst investors, in no small part due to the disappointing performance of the market for the best part of two decades after the peak in the early 1990s.”
Indices performance over 10 years
Source: FE Analytics
However, experts are becoming more optimistic about Japanese equities due to a number of catalysts that should give a new lease of life to this market.
One of those catalysts is the expectation of a shift in monetary policy due to an above-target inflation and the appointment of a new governor at the Bank of Japan.
Jasper Thornton-Boelman, investment director at Parmenion, said: “A movement away from the ultra-easy negative base rate and/or yield curve control policy should provide a tailwind for the yen (as yield differentials versus other currencies reduce) as money is repatriated.
“Money returning to Japanese equities would be a strong positive technical. For overseas investors, a stronger yen would also be a positive for returns once translated back into the home currency.”
Another is that the Tokyo Stock Exchange (TSE) has gone through a reshape with the division of the listed stocks into three categories: the ‘Prime’ section for blue chips, ‘Standard’ section with more relaxed listing requirements, and the ‘Growth’ section for younger companies.
Harry O’Connor, research analyst and head of Japan equities at Brooks Macdonald, said that a recent paper from the TSE is aiming to nudge stocks trading below their book value to cut their discount, with non-compliant companies risking delisting.
He added that this could be a potential tailwind for Japanese equities, which will be encouraged to buy more shares back to improve their price.
A third boost is that Japan benefits from its geographical position to the faster growing Asian economies, with close to 60% of its exports within the Asia Pacific region.
For all these reasons, several wealth managers have been positive on Japan. Currently, the country represents roughly 6% of the FTSE All World and 8% of the MSCI World indices, but Lorenzo La Posta, fund manager at Momentum Global Investment Management (MGIM), said investors can deviate from that depending on their own risk tolerance.
RBC Brewin Dolphin suggested allocating around 7% of global equity allocation to Japanese markets for a broadly balanced portfolio.
Canaccord Genuity Wealth Management’s core model portfolio is overweight Japan, with a -3.8% exposure, compared with a benchmark weighting of 2.7%.
For those that agree, wealth managers had a clear preference for actively managed funds for their exposure to Japanese equities.
Kamal Warraich, head of equity fund research at Canaccord Genuity Wealth Management, said: “Active managers have a higher success rate in Japan compared with some other regions, so we tend to go active.
“There is also considerable research which suggests Japan has a high level of companies experiencing structural issues, and that could imply a higher number of value traps.”
Brooks Macdonald’s O’Connor also prefers an active approach, noting that almost half of Japan’s ‘Prime’ market index companies trade below book value.
Parmenion also showed a preference for active funds, but the wealth manager could consider using passive funds if certain conditions are met.
Thornton-Boelman said: “Looking forward, however, if we moved into a scenario where a lot of money came back into Japan – and into equities – this would theoretically boost the broad market, suggesting a tailwind for passive over an active strategy, that’s focused on company fundamentals.”
However, not all believe now is the time to buy. Analysts at J. Safra Sarasin are less optimistic about Japanese equities and has stayed underweight the region.
Mali Chivakul, emerging markets economist at the firm, said: “We remain cautious on Japanese equities and stick to our underweight position, given the presumed shift in BoJ policy and its consequences for the yen.
“The expected 6.5% appreciation in the trade-weighted yen by year-end would be equivalent to 10% underperformance in Japanese versus global equities.”