Investors burned by a collapse in Japanese asset prices in the past should consider revisiting their allocations as the economy continues to recover from past challenges, according to Hawksmoor Investment Management’s Daniel Lockyer.
Lockyer – a co-manager on the MI Hawksmoor Vanbrugh, MI Hawksmoor Distribution and MI Hawksmoor Global Opportunities funds – said there is a compelling valuation case for Japanese equities.
While there is a long history of market downturns having recovered their losses, said the Hawksmoor manager, Japan has yet to recover from its late-1980s downturn.
He explained: “Throughout history, financial markets have gone through bull and bear phases but in most cases tend to recover eventually so that any correction is a mere blip many years later.
“For example, the 35 per cent crash in UK equities back in 1987 is barely noticeable in the long term.
“But spare a thought for Japanese investors who have perhaps witnessed the deepest and most prolonged bear market in history in both equity and property markets.”
As the below chart shows, while the US S&P 500 has soared since 1990 and the FTSE All Share has also delivered strong returns, the TSE Topix remains in negative territory almost three decades on in price terms.
Performance of indices since 1990 in local currency
Source: FE Analytics
Lockyer said that the 1980s had been a boom time for Japanese assets with the stock market up by 600 per cent while the property market also soared although it later sold off.
“Japanese property values remain a long way below the values reached in the 1980s while the stock market is close to regaining the lost ground 30 years on, during which time most other stock markets are a long way ahead of previous peaks,” he said.
“It is therefore understandable why many investors, both domestic and foreign, choose to ignore Japanese equities having been scarred by past experiences.”
While it might seem surprising that such extreme valuations were reached, said the Hawksmoor manager, “history is littered with examples of investors getting sucked into the latest ‘get rich quick craze’”.
However, Lockyer said that Japanese equities had now reached sound valuations with a margin of safety, helping to reduce the risk of permanent loss to capital.
In addition, Lockyer said the outlook for Japanese companies now looks positive.
“Almost a third of companies in the Topix hold more than 30 per cent of their total market capitalisation in cash, a function of management also being scarred by the bursting of the stock market bubble in 1989,” he explained.
“They spent the following decades paying off debt and building up a cash store for a rainy day.”
The hoarding of cash caused Japanese returns on equity to shrink to very low levels, said Lockyer. Combined with poor corporate governance and long periods of deflation, global investors sought better returns elsewhere and prompted domestic investors to allocate to government bonds.
However, the election of prime minister Shinzo Abe for a second stint in 2012 and his economic reforms known as ‘Abenomics’ have helped to turn around the fortunes of the Japanese economy.
Since Abe took office, the TSE Topix has delivered a total return of 113.3 per cent, in sterling terms, as the chart below shows. In comparison the FTSE All Share is up by just 56.11 per cent over that period.
Performance of index since Abe took office
Source: FE Analytics
“Extraordinary loose monetary policy, including buying equities and bonds as part of its quantitative easing programme, combined with a big fiscal stimulus seem at last to be having an effect,” said the Hawksmoor manager.
Additionally, Japan’s ageing population has had an impact on the economy. While an older, wealthier population has helped increase its GDP per capita, a shortage of applicants in the job market is driving up wages and helping to combat deflation.
“Among the myriad reforms implemented, addressing the demands of shareholders for better governance and focus on returns on equity has been high on the agenda,” he added.
“A relatively new equity index, the JPX Nikkei 400 index, only includes the highest-ranked companies based on certain criteria including a three-year average return on equity and operating profit.
“This has created a catalyst for many companies to change their approach as they competed for inclusion.”
Dividends have also become much more commonplace, said Lockyer, increasing the attractiveness of Japanese equities, with their 1.5 per cent yield putting them on a par with that available from the US market.
“Crucially dividend growth should be greater from Japanese companies given their relatively low payout ratio,” he added.
“Share buybacks and corporate acquisitions are also more common today than before as cash is spent much more wisely.”
The dynamics of the market are also much more attractive with Japan home to some of the world’s leading innovative companies specialising in high-specification technology such as robotics, according to Lockyer.
The Hawksmoor manager added: “We are encouraged by the positive economic backdrop for the first time in many years, stability in the political environment, sustained improvements in corporate governance and valuations that seem to reflect Japan’s historic problems rather than the exciting future prospects.
“Consequently, we believe this progress will ultimately result in better total returns for shareholders than in many other stock markets around the world over the long term.”
While there are challenges to the Japanese outlook – notably its growing reliance on trade with China and the short-term correlation of stock market performance with yen and global markets – the manager said Japanese equities were worthy of an allocation in its funds.
The £141.2m MI Hawksmoor Distribution fund has a 6.2 per cent allocation to Japanese assets; it stands at 5.7 per cent in the £133.1m MI Hawksmoor Vanbrugh fund and 7.7 per cent in the £110.9m in the MI Hawksmoor Global Opportunities fund.
One common holding in the Distribution and Global Opportunities funds is the five FE Crown-rated Jupiter Japan Income – managed by Dan Carter – with both owning the strategy among their top-10 holdings.
Performance of fund vs sector & benchmark under Carter
Source: FE Analytics
Carter joined Jupiter in 2008 and took over the fund at the end of June 2016. Under Carter the fund has delivered a total return of 32.83 per cent compared with a 29.27 per cent gain for the benchmark TSE TOPIX index and a 25.71 per cent gain for the average IA Japan fund.