Japan’s stock market could be set for the best returns in a generation, say analysts bullish about the prospect of an end to decades of deflation and growing levels of shareholder activism — but their optimism has yet to persuade many overseas investors to part with their cash.
Since the start of 2023, Tokyo brokers have hosted waves of investors from around the world attracted by the possibility that an equity market they have ignored since 2018 may now represent an opportunity they cannot afford to miss.
The recent visit to Tokyo of Warren Buffett came with the revelation that he was interested in expanding his Japan portfolio. The hedge fund business of Ken Griffin’s Citadel is planning to reopen its Tokyo office after a near 15-year absence.
However, so far, most visitors are leaving without increasing their positions. In its most recent Global Fund Manager Survey, Bank of America found that respondents’ allocation to Japanese equities fell in the first two weeks of April, decreasing five percentage points from the previous month to a net 10 per cent underweight positioning.
Investors remain wary of another false dawn for a Tokyo market whose rallies have repeatedly proved shortlived. Although Japan’s Topix index has outpaced rivals in Europe over the past decade, it has lagged behind Wall Street. And for foreign investors who don’t hedge their exposure to currency fluctuations, a falling yen has blunted returns.
In the first years of the “Abenomics” era between early 2013 and late 2015, which held the promise of serious market reform led by the late prime minister Shinzo Abe, foreign investors poured roughly $250bn into Japanese equities. But in the years that followed, they have been relentlessly negative and sold almost exactly that same amount.
But strategists and economists are starting to argue that the tide is set to turn. The evidence presented, more than a dozen visiting portfolio managers told the Financial Times, is more compelling than for years.
“For the mass market of global investors, people who haven’t been focused on Japan, there is a force of habit to stick with what you know. Japan has been seen as a pain,” said Drew Edwards, a Japan-focused portfolio manager at GMO Usonian.
“But that means they are not seeing the truly interesting things that are happening. This is a generational shift. People need to stop asking ‘what will it take for Japan to change?’ — it is changing.”
The combination of a new Bank of Japan governor and rising prices is driving speculation that Japan’s days of ultra-loose monetary conditions may be numbered and that the country’s two-decade fight against deflation may finally be over. That should be good news for equities, which typically struggle in an environment of falling prices across the economy.
Japanese stocks should benefit from their unloved status among foreign fund managers, which leaves little potential for a further exodus, according to Alain Bokobza, global head of asset allocation at Société Générale.
“You cannot sell what you don’t own,” Bokobza said, adding that resilient earnings, rising inflation and the prospect of a new wave of share buybacks were making Japanese equities newly “relevant” to global investors.
There are also signs that Japanese companies are becoming more responsive to investors’ interests, as activist shareholders like Elliott Management, ValueAct and an increasing cohort of domestic funds force companies to change their behaviour.
Shares in Honda surged in February after the company announced plans to buy back $500mn worth of its own stock. Shares in Dai Nippon Printing rose by almost 40 per cent in January after it was revealed that Elliott had become one of its largest shareholders.
Japan, according to Man GLG portfolio manager Stephen Harget, is now a unique example of a developed market where it was possible for investors to make large returns “by simply making an AGM proposal that requests a dividend hike or share buybacks”.
However, the reasons for remaining underweight Japan, say fund managers, remain persuasive. It is a difficult market in which to pick stocks without having significant expertise, and an easy market for global investment committees to dismiss. The recent volatility of the yen, which fell rapidly last year, has provided managers with a reason to hold off from investing for now.
The potentially biggest catalyst for a revaluation of Japan, though, may be a surprise policy shift at the Tokyo Stock Exchange. Late last year, and with the subsequent support of the financial regulator, the bourse said that companies with a price-to-book ratio that falls consistently below one should be required to lay out specific plans to improve that situation, and show greater awareness of their cost of capital.
“The naming and shaming framework could be very effective, because underperforming Japanese companies have never been called out like this before,” said Man GLG portfolio manager Stephen Harget. “The reason we are confident that this will make a difference is that the changes being introduced by the TSE have the backing of the government this time.”
Foreign funds do not have large holdings of cheap Japanese stocks with low price-to-book ratios, said one Hong Kong based fund manager at a large global asset manager.
“But that is where we’ve seen some activists getting huge wins and it puts pressure on long-only funds to follow them in to make sure we don’t miss out,” the fund manager said. “There’s a sense of this market being a coiled spring.”
