Asset allocation: why we still like Japanese equities
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Asset allocation: why we still like Japanese equities

The country has taken the latest step on its long-term path to improved corporate capital efficiency, and in a region we have long favoured we continue to see a constructive medium-term backdrop

  • Japan has made another step forward on its long-term path to improved corporate capital efficiency
  • For a long time we have favoured the region and believe this ongoing change has further to run
  • In addition we see a constructive medium-term backdrop for the allocation

Japan is an equity region we have long favoured. Central to this view has been the long-pursued improvement to corporate governance and increased shareholder focus of Japanese firms. In a globalised world where tying regional equity market performance to regional economic outcomes can be misleading, this is an idiosyncratic catalyst that should benefit Japan-listed companies specifically.

As we entered the 1990s Japan’s equity and real estate bubbles burst. This established a cautionary corporate mindset among Japanese firms where excessive cash balances were maintained, which led to reduced levels of return on equity (RoE). From 2012, under the then-president Shinzo Abe’s so-called Abenomics programme, numerous reform efforts have been made at improving Japanese corporate profitability and capital efficiency. The upwards trend in the RoE distribution of the top Topix 500 firms (Figure 1) shows that this appears to have been slowly working. Firms have made efforts to improve capital efficiency and increase the return generated on investors’ equity.

Figure 1: Distribution of Top 500 Topix members’ weights by RoE
Distribution of Top 500 Topix members’ weights by RoE

Source: Bloomberg, 31 March 2023

As the ability of firms to generate returns for investors increases, an observable measure of market appreciation of this is any increase in the price/book (P/B) ratio. And in line with this upwards trend in RoE, the distribution of P/B ratios of the same cohort of stocks has also shifted upwards from its pre-Abenomics profile (Figure 2). However, a significant concentration of firms remains with a P/B ratio around 1x.

Figure 2: Distribution of Top 500 Topix members’ weights by PB
Distribution of Top 500 Topix members’ weights by P/B

Source: Bloomberg, 31 March 2023

In April this year the latest policy move aimed at increasing Japanese profitability was launched. This saw the creation of the “Action Plan for Substantiation of Corporate Governance Reform”1. Key within this is the requirement by the Tokyo Stock Exchange for firms to disclose risk-taking plans and measures taken to achieve growth whilst keeping profitability in mind. In particular, firms with a P/B ratio below 1x will be flagged and requested to “properly identify” their cost and efficiency of capital.

As at the end of July, Japanese equities had rallied almost 16% since this announcement, outpacing global equities in local terms by 5%. Naturally, questions have emerged around whether the potential upside is now factored into prices. We note that the premium in terms of P/B per unit of RoE of Japanese stocks versus non-US global peers has increased (Figure 3). However, it has only moved to the extent that a 0.5% increase in RoE would shift this back to median levels (Figure 4).

 

Figure 3: Japanese P/B per RoE premium to global peers
Japanese P/B per RoE premium to global peers

Source: Bloomberg, 9 August 2023

Our Global equity team have flagged that the magnitude of cash on some Japanese firms’ balance sheets provides clear opportunities to increase RoE by around 5%. As such we do not currently view the Japanese rally as overextended.

Figure 4: RoE required to revert to median premium
RoE required to revert to median premium

Source: Bloomberg, 9 August 2023

Aside from the long-term reform-driven upside for Japanese equities, we also see medium-term tailwinds from both the domestic and external environment. On the domestic front, lingering Covid restrictions into 2022 set a low starting point for activity, relative to other regions. Today, consumer confidence has recovered, household balance sheets are healthy and domestic consumption still has room to improve before it reaches pre-Covid levels. The scope for Japan’s tourism industry to continue improving relative to 2019 levels is also notable. 

Figure 5: JPY/USD year-on-year versus MSCI Japan forward earnings per share Y/Y
JPY/USD year-on-year versus MSCI Japan forward earnings per share Y/Y

Source: Bloomberg, 9 August 2023

From an external perspective, the case can be made for an upcoming period characterised by a change to the typical inverse JPY and Japanese earnings relationship (Figure 5). Increased non-Bank of Japan key developed market central bank rates have reduced global growth expectations and associated cyclical Japanese earnings expectations, while depreciating the JPY through increased rate differentials. From here, with rate differentials expected to gradually reduce from both sides, alongside a potential bottoming of the global cycle, the case can be made for an appreciation in JPY alongside an increase in Japanese earnings. This provides an attractive set-up for non-JPY-based investors like us.

18 August 2023
Ben Rodriguez
Ben Rodriguez
Fund Manager, Multi-asset
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Asset allocation: why we still like Japanese equities

1 Japan Financial Services Agency, Action Program for Accelerating Corporate Governance Reform: From Form to Substance, 26 April 2023

Important Information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). This is a marketing communication. The mention of stocks is not a recommendation to deal.

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act and relies on Class Order 03/1102 in marketing and providing financial services to Australian wholesale clients as defined in Section 761G of the Corporations Act 2001. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.

In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.

In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.

In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association.

In the UK: Issued by Threadneedle Asset Management Limited. Registered in England and Wales, Registered No. 573204, Cannon Place, 78 Cannon Street, London EC4N 6AG, United Kingdom. Authorised and regulated in the UK by the Financial Conduct Authority.

In the EEA: Issued by Threadneedle Management Luxembourg S.A. Registered with the Registre de Commerce et des Societes (Luxembourg), Registered No. B 110242, 44, rue de la Vallée, L-2661 Luxembourg, Grand Duchy of Luxembourg.

In Switzerland: Issued by Threadneedle Portfolio Services AG, Registered address: Claridenstrasse 41, 8002 Zurich, Switzerland.

In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors’ with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

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Important Information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). This is a marketing communication. The mention of stocks is not a recommendation to deal.

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act and relies on Class Order 03/1102 in marketing and providing financial services to Australian wholesale clients as defined in Section 761G of the Corporations Act 2001. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.

In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.

In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.

In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association.

In the UK: Issued by Threadneedle Asset Management Limited. Registered in England and Wales, Registered No. 573204, Cannon Place, 78 Cannon Street, London EC4N 6AG, United Kingdom. Authorised and regulated in the UK by the Financial Conduct Authority.

In the EEA: Issued by Threadneedle Management Luxembourg S.A. Registered with the Registre de Commerce et des Societes (Luxembourg), Registered No. B 110242, 44, rue de la Vallée, L-2661 Luxembourg, Grand Duchy of Luxembourg.

In Switzerland: Issued by Threadneedle Portfolio Services AG, Registered address: Claridenstrasse 41, 8002 Zurich, Switzerland.

In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors’ with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

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