Originally published by BetaShares
Incredible food, stunning country side scenery, gadgets galore, brilliant and efficient public transport, it’s a little quirky, it has amazing culture and has sights and sounds that make your senses come alive – Japan sure is a great place to go for a holiday and/or business trip. It is also a destination that more of us should possibly consider investing in. I’m sure many of you have heard this before and so have I, however, in my view there are several compelling reasons for you to re-consider Japan this time.
Firstly ‘the tourists’ have gone… well not the tourists in the traditional sense, alas even Jetstar flies there these days. I’m referring to the foreign investors who flooded the Japanese equity market on the back of the hype of ‘Abenomics’. Over the past 18 months, foreign investors have sold off 4% of the Japanese market capitalisation and are now very much underweight Japanese equities. 2016 has seen the biggest flight from Japanese equities by foreign investors since 1987. But the good news is that the locals have stepped up. The domestic institutional asset managers, the pension funds, the local insurance companies and so too the local ‘Haha’ and ‘Chichi’ (Mum and Dad) investors are now net buyers of Japanese equities – the first time this has occurred in the past 20 years. It seems that you might want to be with the locals, and not with the tourists. The largest of Japan’s institutional investors – the Government Pension Investment Fund (GPIF) has now increased their weighting of local equities from 14% to 25%. The private pension (superannuation) funds and insurance companies are expected to move in the same direction, currently holding a weight of around 12% in Japanese equities – this could rise to over 20%.
Why is this occurring? Prime Minister Abe and the Bank of Japan are committed to an expansive fiscal policy, whereby 1% of GDP over the next year has been reserved to buy Japanese equities (worth noting – largely through Exchange Traded Funds). Currently, the BOJ owns about 4% of the local market and by this time next year they will potentially own around 6%. This in turn is going to assist in turning around what has been negative earnings momentum over the past 15 months. Over the past year, earnings decreased around 15% and this was largely due to an appreciating Yen and disappointing stagnant global growth. On a valuations basis, the Japanese market (as measured by the TOPIX) is trading at a PE of just under 16X, which is at a decent discount to its own valuation history – and throughout the ‘Abenomics’ period average PE has been over 17X. However, earnings revision momentum is poised to turn around now on the back of fiscal policy. Further, the Bank of Japan is anchoring the ten-year bond yield at zero. Let’s repeat that again – ten year rates anchored at zero. Short terms rates are at -10 bps. As such, Japan will have the flattest yield curve in developed markets. So back to the local Japanese institutional investors – Japan Post, the GPIF, the insurance companies. They have seen rates go from 5% down into negative territory and, importantly, what are they managing? Long dated liabilities, which need to matched with appropriate assets. However, as they will now get zero by holding Japanese Government Bonds, they are essentially being forced to turn to the equity markets in order to manage their assets and liabilities.
Secondly, there has been a revolution in corporate culture and stewardship. Japan used to be perceived as a corporate club – if you were not part of the Mitsubishi or Sumitomo families, you were left out of a very small and influential ‘club’. Change is occurring, however, with a new corporate governance and stewardship code having been implemented by the government. For example, Japanese companies can now be held accountable for building up retained earnings and, for the first time in the Japanese equity market history, we are seeing a focus on shareholder returns, especially through the payment of dividends. A dividend stream was virtually non-existent in the Japanese sharemarket up until recently, and now we see the Topix (benchmark Index for Japan) paying out a yield of ~2%. Still a way to go for improving corporate culture, but there have been positive developments in this area.
Thirdly, we come to the topic of political stability. In the past four years we in Australia have gone through four Prime Ministers. By contrast, Japan has had one in four years. Prime Minister Abe presides over a very stable government and has a massive two thirds majority in parliament, creating a strong and well-coordinated government. In addition to this, PM Abe was the first global leader to meet President Elect Trump in what was clearly a positive sign for Japanese-US financial and economic relations. Throughout the election build-up, Team Trump signalled an agenda to boost and build new infrastructure projects in the US. Think new ports, new motorways, airports, bullet trains. Japan could well be a major beneficiary of this program via projects built in the US, but with Japanese ‘know-how’. ‘The Donald’ also indicated his willingness to cut corporate taxes. Approximately 14% of Japanese corporate profits come from US based production, hence any tax cuts might be an additional boon for Japanese companies.
Lastly, theory suggests a benefit in being currency hedged when investing in Japan, something my colleague David Bassanese covered recently. Why? Well, as mentioned above, remember what the BOJ is trying to do? It wants a weaker yen against the USD and is doing what it can to achieve this, meaning you have a structurally weakening yen. Also, as David’s blog indicated, history has shown that a strong performance in the Japanese equities market is often accompanied by a weakening Yen (due to the importance of exports to the market). By investing on a currency hedged basis, you essentially remove the currency risk, so that a weakening Yen should not detract from the equity returns when converted to Australian dollars.