21 October 2019

The investment case for Japan

Many investors avoid allocating to Japan justifying their decision by its cyclicality, stubborn disinflation, challenging demographics and the usual concerns surrounding weak economic growth.

by Charles Bathurst-Norman

Investment Director

Japan may not seem like an obvious choice for international investors, but there are several catalysts on the horizon that could make it more attractive. Politically, Japan remains one of the most stable countries in the developed world. Prime Minister Shinzo Abe’s victory by a clear majority in the Upper House elections in July has cemented his status as Japan's longest serving Prime Minister.  Under his economic policies coined ‘Abenomics’ (based upon the three arrows of monetary easing, fiscal policy and structural reforms) Japan’s economy is experiencing its longest expansion since the war with a sustained increased in real GDP, real wages increasing and unemployment having fallen below 2.5 per cent to its lowest level in 23 years, aided by the recent increase in female workforce participation.

Japan’s economy has also taken on a new shape with the introduction of Corporate Governance and Stewardship Codes, which aim to increase the earning powers of companies through reforms in corporate governance. Despite criticisms and the difficulty in understanding the nuances of company behaviour, the positive impact for the Japanese economy can be felt with increasing shareholder returns through dividends and buybacks continuing to rise for an eighth consecutive year and a dramatic rise in the number of independent directors appointed to company boards.   

Whilst volatility and set-backs from time to time will happen, taking an approach of avoiding an asset allocation to Japan deprives investors of a major component of the global equity market, where a number of global leading businesses are listed. Growth strategies have now outperformed value over the last five years, reversing a trend where value outperformed growth for more than twenty years. In areas ranging from industrial robotics, niche areas within semiconductors and machinery, Japanese companies enjoy world leading competitive advantages and long runways of future earnings growth. The Internet continues to allow companies to compete against incumbents with a powerful combination of a lower cost-base and better service and new categories of growth companies continue to appear - emerging healthcare and drug discovery being a recent examples. 

Another feature of the Japanese market that merits attention is valuation. Unlike other markets globally, the broad market Topix industry has de-rated over the past five years and now commands a historically low rating, some 20% below US equities. This provides an excellent backdrop for long term stock pickers with a value bias.

When we look at all these improvements we already get a good story and feel Japan remains an exciting investment opportunity. Add to that the potential for further progress on shareholder-friendly corporate reform via increasing dividend yields or share buybacks, plus the enthusiasm generated by the 2020 Olympics in Tokyo following the Rugby World Cup, it becomes a compelling one. Japan provides not only currency and asset diversification to portfolios, but a source of potential income and capital appreciation with exposure to solid economy where companies with strong balance sheets are seen as undervalued. I consider Japan a key investment theme and remain positive on the outlook for Japanese investments as an option for asset allocation for private client portfolios.

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