Japan has recently surged past its developed market peers and is one of the darlings of fund managers at the moment, following a strong couple of years in general. But retail investors seem decidedly turned off by the country.
Japan was out of the minds of most investors following a deflationary spiral that lasted more than two decades but returned to favour in 2012 when the new prime minister Shinzo Abe unveiled an ambitious package of reforms that were soon dubbed ‘Abenomics’.
The Nikkei 225 has been one of the highest returning markets over 2015 so far, posting gains of more than 20 per cent in sterling terms while the FTSE All Share and the S&P 500 remain below the 10 per cent mark.
Performance of indices over 2015
Source: FE Analytics
Since the start of 2013, when investors were starting to digest the impact of Abenomic’s three arrows of fiscal stimulus, monetary easing and structural reforms, the Nikkei 225 has gained 52 per cent.
While it’s been outpaced by the S&P 500, which until recently seemed to be on an almost-relentless rise, sterling investors would have done better in Japan than in the FTSE All Share or global emerging markets.
What’s more, Japan is seen alongside Europe as being one of the few pockets of value remaining in global markets. A recent FE Trustnet survey of leading fund buyers showed 34.38 per cent are most optimistic about Japan on the three-year view, with Europe getting the same score.
As the chart below shows, none of the other options had anywhere near as much sentiment behind them.
Source: FE Trustnet
In each of the first three months of 2015 asset allocators extended their overweight to Japanese equities, the latest Bank of America Merrill Lynch Fund Manager Survey showed, as investors moved towards a net underweight in every other market apart from Europe.
Despite this, interest in the country from investors has remained subdued. Anecdotally, the word ‘Japan’ appearing in an FE Trustnet headline also guarantees that the story will not be read; notice how it wasn’t used in the headline for this article?
Fund flow data for the first nine months of 2013, when Japan was first catching the attention of professional investors, appears to back this up.
Data from the Investment Association shows that during this period net retail inflows into the IA Japan sector did not break £70m a month – often being far below this and with one month seeing money being pulled out of the peer group.
Retail inflows were stronger during the first few months of 2014, coinciding with a time when Japanese stocks handed back some of their gains. They then tailed off after the summer, with net outflows being seen in the year’s last two months.
Things might be on the turn, however. Net retail inflows into the IA Japan rocketed from £7m in January to £173m in February – their strongest in some time.
Japan has always been somewhat of a “Marmite” market, according to JP Morgan Asset Management global market strategist Kerry Craig, but Abenomics has made this even more the case. However, he also believes that looking at Japan just in terms of whether Abenomics will work or not might be mistaken.
“The ambitious suite of stimulative economic policies inspires dedicated faith from investors who believe in its power to reverse decades of deflation, whilst others are more likely to dismiss its potential and instead loath the prospect of yet another false dawn,” he said.
“However, a belief in the success – or otherwise – of Shinzo Abe’s plan to reignite the economy may not be the right investment thesis for Japan. There are other reasons why equity markets may continue to move higher. The country’s deep-seated economic challenges should make any long-term investor stop and think, but a few things are starting to swing in Japan’s favour and the market may well be worth another look.”
Craig says the price of the Japanese equity market is its “most obvious attraction”, as compared with its own history and the history of its developed world peers, it remains cheap. The Nikkei 225 has risen almost 180 per cent since its low in March 2009 while its forward price/earnings ratio of 18.9 times, against a 15-year average of 21 times.
“Marmite haters will say that it’s just the weaker currency and not a genuine improvement. However, unlike 2013, when market gains were accompanied by a significant depreciation in the yen, this year’s gains show no more than enthusiasm based on central bank balance sheet expansion. In fact, there could be a combination of factors at play,” he added.
The strategist cites earnings momentum as another positive, noting that Japan had strongest earnings momentum of all three major developed regions in the last quarter of 2014 while 67 per cent of Topix companies beat their earnings expectations.
Meanwhile, Japanese equities should benefit from continued support from fund inflows, coming from the Government Pension Investment Fund’s need to invest $59bn in Japanese equities to achieve its target of a 25 per cent equity weighting and the expectation that the Bank of Japan will invest $25bn into stocks as part of its qualitative and quantitative easing programme.
“There have been too many false dawns in Japan for any investor to consider its equity market to be a sure thing,” Crag said.
“Given the depth of the country’s structural problems, it’s admittedly too early to judge whether Abenomics is working. But the Japanese equity market has had an excellent start to the year and there are several reasons to think that it will be supported in the medium term: attractive valuations, decent earnings momentum and continued structural support from official sources.”
In an article later this week, FE Trustnet will look at the portfolio construction reasons why UK investors should consider holding a Japanese equities fund and those that could be an attractive option. But if you’re a real Japan bull or bear, please let us know why in the comments below.
