Despite posting impressive gains in 2023, Japanese equities seem under-appreciated among global investors. What’s behind this discrepancy in the world’s third-largest economy?
Japanese stocks have notably outperformed their counterparts this year. Both the Nikkei 225 index and the Tokyo Stock Price Index (Topix) have surged by 25 per cent, overshadowing the US S&P500’s 14 per cent and the European Stoxx 600’s nearly six per cent rise. Backing this equities’ climb, Japan’s economy reflects robust growth, outpacing both the US and Europe, with its second-quarter GDP marking an annualised growth rate of 6 per cent.
Fund managers’ reluctance
Despite these numbers, active portfolio managers are largely underweight on Japan. A staggering 84 per cent of strategies that benchmark against the MSCI EAFE index - which tracks developed markets outside the US - remain underweight on Japan. “The underweighting often results from a structural bias rather than comprehensive fundamental analysis,” argued Rick Friedman and Drew Edwards of GMO. They pinpoint hurdles like significant time zone differences, language barriers, and unique market peculiarities that make understanding Japanese stocks a challenge.
Edwards highlights that limited effort is made by global investors to engage with small to medium-sized Japanese enterprises, where significant opportunities often lie. This oversight, combined with a general wariness to navigate the Japanese market, results in reserved investment. Interestingly, the Japanese themselves are also cautious. Bank of Japan data reveals that Japanese households commit just 11 per cent of their savings to equities, with a whopping 54 per cent left in cash and bank deposits.
Underweighting Japan by active funds using MSCI AEFE as benchmark
Cultural investment mindset
The investment approach starkly contrasts with the US, where households commit nearly 40 per cent of their wealth to the stock market, leaving only 13 per cent in cash and deposits. Hidekazu Ishida of Fincity Tokyo attributes this discrepancy to cultural perspectives, stating that many in Japan view investing as “very risky” and finance as “not cool.”
Van Lanschot Kempen, based in the Netherlands, has however ramped up its Japan allocation. They cite concerns about stringent monetary policies in the US and the eurozone, issues that don’t currently affect Japan. The Bank of Japan’s accommodating monetary stance, juxtaposed with tightening in the US, has caused the Japanese yen to weaken, nearing the 150 yen per US dollar threshold - a point where interventions have occurred in the past.
Looking ahead
Speculations arise that Japan might conclude its negative policy interest rates by year’s end. However, a strict monetary policy remains distant. “A normalisation of inflation and monetary policies might boost confidence in the Japanese economy,” suggests Van Lanschot Kempen. GMO International Equity Strategy remains steadfast in its Japan overweight stance, a sentiment echoed across other GMO strategies.