Gradual improvements to corporate governance in Japan and the increased shareholder focus within domestic firms should give investors confidence in Japanese equities over the medium term.
“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,” said Ben Rodriguez, multi-asset fund manager at Columbia Threadneedle Investments. “We see a constructive medium-term backdrop for the allocation.”
He cites the positive impact of reform efforts to enhance Japan’s corporate profitability and capital efficiency that began in 2012 under then-president Shinzo Abe.
“The upwards trend in the return on equity distribution of the top Topix 500 firms shows that this appears to have been slowly working,” explained Rodriguez.
He continues to see more firms now able to generate returns for investors, supported by the increase in price/book (P/B) ratios. “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,” he added.
Upward trajectory
Despite already favouring Japan for some time, CTI believes the ongoing changes have further to run.
For example, the latest policy move to improve Japanese profitability was launched in April 2023 with the “Action Plan for Substantiation of Corporate Governance Reform”. The Tokyo Stock Exchange now requires listed firms to disclose risk-taking plans and measures taken to achieve growth whilst keeping profitability in mind.
In particular, said Rodriguez, firms with a P/B ratio below 1x will be flagged and requested to “properly identify” their cost and efficiency of capital.
As of 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,” added Rodriguez, who noted that the premium in terms of P/B per unit of RoE of Japanese stocks versus non-US global peers has increased. “However, it has only moved to the extent that a 0.5% increase in RoE would shift this back to median levels.”
A compelling case
At the same time, the amount of cash on the balance sheets of some Japanese firms provides clear opportunities – in CTI’s view – to increase RoE by around 5%.
“As such we do not currently view the Japanese rally as overextended,” added Rodriguez.
His view is also fuelled by some medium-term tailwinds from both the domestic and external environment.
At home, consumer confidence has recovered after prolonged restrictions due to Covid-19, supported by healthy household balance sheets. There is also scope for Japan’s tourism industry to rebound, he added.
Externally, Rodriguez believes there is a case for the Japanese yen (JPY) to appreciate alongside an increase in Japanese earnings. “This provides an attractive set-up for non-JPY-based investors like us.”
