The sun shines on Japan as investors turn to the East: Japanese equities could be heading for a multi-year bull run

Global investors are facing an unusually high number of risks in different parts of the world.

 

The Greece crisis has been a headache for European investors, while over in China the unravelling of a stock market bubble is giving cause for concern. Meanwhile US shares are trading close to record highs, and many believe they are overvalued.  

 

 

Now many investment managers think Japan stands out as the last area of real opportunity, and may be  at the start of a long bull market. 

 

“The opportunity is bigger than it has been for 20 years,” says Valentijn van Nieuwenhuijzen at NN Investment Partners. 

 

Japan has been one of the best performing equity markets in the world so far this year. The Nikkei 225 has risen 10.6 per cent year to date, compared with just 2 per cent from the US’s S&P 500, and 3 per cent from the FTSE 100.

 

 

Over the last several decades Japan’s economy has faced some serious problems. 

 

Known as “Japanisation”, the country struggled with deflation and had very little economic growth. At first this was known as Japan’s “lost decade”, but that soon morphed into two lost decades. Unsurprisingly, returns on the stock market were pitiful.

 

All that began to change when Prime Minister Shinzo Abe announced a three-pronged strategy for lifting Japan out of the dump and kick-starting the economy.  Dubbed “Abenomics”, the plan involved QE to pump trillions of yen into the economy.

 

QE in the UK and the US has helped the economy recover, and it is hoped this will be replicated in Japan. Most importantly for the far eastern state, economists hope QE will help create inflation, after so many years of price falls. Inflation will mean companies can raise prices and thus their profits – good news for investors.

 

Reversing two decades of economic decline is like turning around a supertanker. It will take a long time, and Japan’s economy has its critics. “It is still common to read that the jury remains out on the success of Abenomics… some commentators even suggest that Abenomics isn’t working at all,” explains Sarah Williams of Columbia Threadneedle Investments. 

 

 

But over on the stock market, things are changing. Japan is home to the largest state pension fund in the world, and the government recently made a landmark move in encouraging it to invest more in Japanese stocks. 

 

The change means over $1 trillion of pension cash will be invested in local markets, which is a huge boost.

 

 

The other big problem for Japan has been corporate culture. Businesses are deeply hierarchical, wedded to tradition, and the pace of change is glacial. 

 

Return on equity (ROE), a common measure of efficiency in business, is terribly low in Japan. So authorities have created a new stock market index, the JPX-Nikkei 400, showcasing the companies with the highest levels of ROE. 

 

Businesses have clamoured to be included and prove they can be among the best. This is the key which many believe will unlock more focus on shareholders and better stock market returns in Japan.

 

“A behavioural shift is happening among Japanese companies. The focus is on shareholder value,” says Patrick Moonen at NN Investment Partners.

 

 

Japan is not an easy market in which to make quick gains, and when allocating any cash to the market, investors should consider it a long-term play of many years. 

 

Investors wanting to add some Japan exposure to their portfolio could buy a dedicated exchange traded fund (ETF) tracking the major markets. Jason Hollands of Tilney Bestinvest often suggests the iShares MSCI Japan GBP Hedged Ucits ETF for his clients. 

 

It costs 0.64 per cent annually in an ongoing charge, which is more expensive than some other Japan ETFs out there, but this one “hedges” the yen. 

 

This means it tries to mitigate the effect of currency moves on people investing with sterling. This is important as Prime Minister Abe is deliberately trying to weaken the yen.

 

A cheaper option is the Vanguard Japan Stock Index GBP ETF, which has a 0.23 per cent annual ongoing charge. This is more of a vanilla choice, as it costs less and doesn’t do any fancy currency hedging.

 

These funds will give an investor just the return of the index, less charges. So while they are cheap, the potential for money making is also somewhat limited.

 

For those preferring to try active funds, Sheridan Adnams at The Share Centre highlights the top-performing Legg Mason IF Japan Equity fund as a good choice. 

 

She also likes the Neptune Japan Opportunities fund, which invests in large and medium-sized companies.