What are the prospects for Japanese equities?, May 2023

Japan certainly hasn’t emerged unscathed from the global problems that have blighted most international markets over the past year.

Elevated inflation levels and the fall-out from Russia’s invasion of Ukraine made life unpredictable and challenging for many investors. There was also the assassination last summer of hugely respected former Japanese prime minister, Shinzo Abe, who had helped transform the country’s finances.

However, fund managers covering Japan remain undeterred. In fact, many of them are optimistic about its future prospects. Here we take a look at where their portfolios are focusing attention and the interesting stock opportunities they have discovered.

Yen weakness

Chisako Hardie, manager of the AXA Framlington Japan fund, recently suggested currency weakness could be very positive for the country’s longer-term prospects. “The strong sensitivity to the weaker yen for corporate profits should create an economic boom, and as such should be extremely beneficial to Japan within the coming 12 months,” she said.

Chisako, whose fund tends to have a slight bias towards smaller companies, favours those with long-term growth prospects that are independent of short-term news flow. Currently, one of the 10 largest stock holdings in the fund is Komatsu, the global maker of mining and construction equipment*. “This is a way to increase the weighting to the buoyant commodity space,” Chisako explained.

Corporate governance

According to Sam Perry, manager of the Pictet Japanese Equity Selection fund, Japan’s corporate governance overhaul is about to enter a new phase. In a recent outlook piece, he pointed out that prime minister Fumio Kishida’s flagship initiative appeared to be based on persuading Japanese citizens to buy domestic stocks. “Kishida is urging the country’s traditionally risk-averse, cash-rich investors to manage and invest their assets proactively,” he wrote.

The fund, which embraces a high conviction strategy that invests in large and medium-sized businesses, has enjoyed strong returns since its inception. Currently, multinational conglomerate Sony, which is a globally recognised name in electronic goods, is the fund’s largest holding with a 4.25% allocation*. On a sector level, information technology is the most significant with 23.93%, followed by 19.57% in consumer discretionary names and 17.30% in industrials*.

Winners and losers 

Archibald Ciganer, manager of the T. Rowe Price Japanese Equity fund, is broadly upbeat about prospects for the coming months. In an update, he pointed out that Japan’s corporates continue to buy back stock and return capital to shareholders at record levels, despite the global economic uncertainty. “This is an encouraging sign about their health and signals the ongoing improvement in corporate governance at the company level in Japan,” he said. “We believe the relentless pressure of late creates opportunity for long-term investors.”

Keyence, which develops and manufactures automation sensors, has been one of the largest recent contributors to performance, according to fund data to the end of March 2023. Tokyo Electron and Sony have also done well. Conversely, Mitsubishi UFJ Financial, the bank and financial services holding company, has been a detractor.

Other interesting stocks 

Over in the Baillie Gifford Japanese Income Growth fund, the largest stock holding is currently FANUC, a dedicated specialist for factory automation**. This relatively new fund, which was only launched in 2016 and is run by Matthew Brett and Karen Se, looks to benefit from improving corporate governance in Japan.

The managers apply their well-tested growth investing philosophy with a focus on companies that are improving returns on capital and balance sheet efficiency. Not only does this fund tap into an exciting change in dividend attitudes in Japan, but it also has the benefit of the Baillie Gifford Japanese equity team, which is one of the best in the business.

Smaller opportunities 

When it comes to smaller companies, there is a plethora of choice in Japan. One example is Sanrio, which has been a focus of attention for the M&G Japan Smaller Companies fund over the past couple of years as it was felt to be underperforming its potential. The business owns the intellectual property for the Hello Kitty character and last summer agreed a licensing deal with China’s e-commerce giant Alibaba.

The team told us that the company had been “open to our suggestions” about its China strategy and the profile of its senior management team. “The stock has nearly quadrupled since we first invested in 2020 and is a great case study for how M&G’s active management programme creates win-wins for companies and investors alike,” they said.

*Source: fund factsheet, 31 March 2023
**Source: fund factsheet, 30 April 2023

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and fund managers do not constitute financial advice.