Japan has repeatedly failed to deliver on promises to reform, but it is showing signs of real change for the first time in over 14 years. The market has disappointed with multiple “false dawns” in the past, but impactful governance changes have made the region far more attractive this time around.
IBOSS’ allocation to Japan
Historically, until 2018, we didn’t hold Japanese funds explicitly; instead, we used ‘Asia (including Japan)’ alternatives. We did this because we spent much time trying to guess when the right moment would be to invest in Japan, and we learned that, like so many others, we didn’t have the skill set to do that. So, we outsourced that decision to the individual fund managers we trusted.
That changed in 2018 when we began allocating to explicit Japanese funds, initially only a small 2% holding, which slowly increased over time. Our allocation is currently between 4% and 6%, which is the highest we’ve ever held in our portfolios.
Fund managers’ positive sentiments and convictions regarding Japan’s current outlook are compelling. While it’s true that their optimism is not without bias, the heightened excitement and passion they exhibit convinced us that significant changes are underway in Japan’s economic priorities. This time, it appears to differ from previous instances where similar claims were made but failed to change the corporate culture.
What is also noteworthy to witness is the level of consensus and enthusiasm among not only Japanese managers of the funds we’re holding but also of their counterparts and managers from other regions. When professionals from various backgrounds and perspectives converge on a shared belief, it adds weight to the notion that transformative shifts are taking place.
Improvements in corporate governance
The shift towards prioritising shareholder value in Japan is indeed a significant development that has caught the attention of market professionals. Historically, Japanese companies have been known for their cash-rich positions but are often criticised for poor governance. There has been a perception that shareholders, predominantly minority shareholders, were not given adequate consideration in Japanese corporate governance practices.
However, it appears that the Japanese government and companies have recognised the importance of addressing this issue and have taken steps to improve shareholder rights and interests. The Japanese government has implemented reforms and initiatives to promote shareholder value, such as revisions to the Corporate Governance and Stewardship Codes. These measures aim to enhance transparency, accountability, and the protection of shareholder rights, and companies are now actively engaging with shareholders, holding more regular and constructive dialogues.
The growing emphasis on shareholder value is also influenced by the changing global landscape and the need for Japanese companies to compete internationally. They recognise that a strong shareholder base can contribute to long-term sustainability and attract investment.
Aligning with the West
The shift is towards running companies more akin to European or US standards and indicates a broader systemic change rather than isolated improvements within individual companies. This groundswell change suggests a collective effort to align Japanese corporate practices with those of the West, as it hopes to attract more foreign investment moving forward, and the evidence is that it is so far working.
The recent upbeat data and Warren Buffett’s bullish stance on Japan further reinforce the growing confidence in the country’s potential. High-profile endorsements can often influence investor sentiment and bring attention to emerging opportunities. As an example, we were recently contacted by Japan’s most subscribed daily newspaper for comment on the Japanese market. The first thing they asked was – “has Buffet’s buying of Japanese assets influenced our own decision to explicitly invest in Japan?”
Reopening economy
Another often overlooked tailwind is the reopening of trade in the country. While media coverage tends to focus on the reopening of China after Covid-related lockdowns, Japan’s reopening is also significant.
The lifting of pandemic restrictions, such as mandatory mask-wearing in March of this year, marks an important milestone for Japan’s economy. The gradual return to normalcy has the potential to spur economic activity and drive growth across various sectors.
As trade resumes, it can positively impact industries such as manufacturing, exports, tourism, and supply chains. Furthermore, the reopening of trade allows Japanese companies to regain domestic momentum and facilitates international business interactions.
Considering the underappreciation of Japan’s reopening compared to other countries, investors who recognise this potential opportunity may find themselves well-positioned to capitalise on the country’s economic resurgence.
Diversification benefits
Japan’s relatively low correlation with other areas, such as India, China, and Brazil, makes it an attractive addition to our portfolio for diversification purposes. This low correlation means that the performance of Japanese investments may not move in lockstep with other equity holdings in our portfolios.
By incorporating assets outside of the traditional UK, US, and European holdings, we aim to reduce the impact of market volatility by investing across different asset classes and geographies. During market turbulence or regional-specific events, exposure to Japan can potentially provide a cushioning effect. This approach helps to reduce concentration risk and increase the likelihood of achieving more stable and consistent risk-adjusted returns.
Currency matters
The fluctuations between sterling and the yen can introduce uncertainty and add additional layers of complexity and risk to our portfolios. Managing currency risk is an important consideration when investing in foreign markets, and our decision to hedge a third of our Japanese holdings in August 2022, when Sterling was struggling, has helped smooth out the returns.
Forecasting currency movements is a complex business, even for experts and managers who have teams of specialists. We have observed over many years that when an asset reaches record highs or lows, the perceived risks can become asymmetric. We have seen this in the extreme sovereign bond yields, currencies such as sterling and stocks that become predominantly driven by momentum rather than fundamentals.
While many managers argue that currency fluctuations average over time, it’s important to acknowledge that sustained periods of currency movements in a particular direction can impact returns for extended periods. By employing a hedging strategy, we aimed to minimise the impact of currency fluctuations on our portfolios, instead focusing on the underlying fundamentals and potential returns of the funds themselves.
Back at the table
Japan is undoubtedly a hot topic right now. We are bullish on Japan and slightly overweight relative to our benchmarks, but the debate now is whether we go further overweight.
It is not uncommon for different views to emerge based on varying experiences and historical perspectives. Members of our investment team who were around in the late 80s and 90s carry memories of Japan’s economic bubble and subsequent periods of stagnation, which can influence their perception of the country’s current potential. However, it is essential to recognise that economic dynamics can change significantly over time, and occasionally things are actually different!
Assessing the fundamentals of Japan is a crucial step in determining its relative attractiveness. If the fundamentals align with other positive indicators, it provides a solid rationale for considering an increased overweight position. We will continue to research, analyse the current market dynamics, and evaluate the long-termer prospects with the help of our Japanese managers.
However, given the undeniable tailwinds, Japan’s potential cannot be ignored, so we believe it deserves its place back at the table after a long period away.
This communication is designed for informational purposes only and is not intended as investment advice. These investments are not suitable for everyone, and you should obtain expert advice from a professional financial adviser. Please note that the content is based on the author’s opinion at the time of writing/publish date. Our views and opinions regarding certain investment themes and topics can alter over time as the macroeconomic background changes and other industry news is made publicly available, this is not intended as investment advice.
Past performance is not a reliable indicator of future performance. The value of investments and the income derived from them can fall as well as rise, and investors may get back less than they invested.
IBOSS Asset Management is authorised and regulated by the Financial Conduct Authority. Financial Services Register Number 697866.
IBOSS Asset Management Limited is ultimately owned by Kingswood Holdings Limited, an AIM Listed company incorporated in Guernsey (registered number: 42316).
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