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Why Australian investors should consider Japanese equities

Anthony Fensom  |  26 Oct 2016Text size  Decrease  Increase  |  

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Improved corporate governance, economic stimulus measures and a bearish outlook for the yen bode well for equities in the land of the rising sun.


Japanese stocks have lost ground in 2016, with a rising exchange rate dampening exporters' profits and foreign investors retreating from the market.

However, analysts point to improved corporate governance, economic stimulus measures and a bearish outlook for the Japanese yen as positives for equities in the land of the rising sun.

On 24 October, the Nikkei closed at 17,234, down on its year-high of 20,012 but well off its 52-week low of 14,864.

Foreign investors, which represent nearly 70 per cent of market trading, are on track for their biggest annual exodus since 1987 after reducing their holdings in four of the past five months, selling more than US$59 billion of Tokyo stocks, according to Bloomberg data.

The foreign selling has offset the Bank of Japan's (BOJ's) monetary expansion, including buying US$58 billion worth of exchange-traded funds.

Meanwhile, the Japanese yen has gained 16 per cent against the US dollar this year on the back of its "safe-haven" status amid Brexit and other geopolitical volatility, while the central bank's move to implement negative interest rates has curbed bank profits.

Yet with the benchmark Topix Index trading at 13 times projected earnings for the next 12 months, compared to its 10-year average of 15 times, analysts suggest the market's fundamentals remain positive.

"The foreign selling is very clearly overdone," Mikio Kumada, executive director at LGT Capital Partners, told Bloomberg.

"The BOJ will make a move. The yen should weaken again and the equity markets will rise".

Investment opportunities

One fund manager bullish on Japanese equities is Nikko Asset Management (Nikko AM).

On 4 October, Nikko AM's global investment committee said it was "positive on Japanese and developed Asia-Pacific equities over the next six months due to low valuations in Japan and a bullish outlook for Hong Kong and Australian shares".

The committee forecast half-year Japanese GDP growth of 0.8 per cent, with the Topix predicted to rise by 6.7 per cent in local currency terms through to March 2017.

It said the BOJ would likely maintain its current monetary policy settings for the next six months, with the yen expected to stabilise around 100 against the US dollar providing the US Federal Reserve does not hike rates more than once.

Australian investors have the opportunity to share in the predicted upside for Japanese stocks, with the 20 September launch of the Nikko AM Japan Share Concentrated Fund.

According to Nikko AM, the fund aims to achieve capital growth over the long term and provides investors with exposure to "an actively managed and relatively concentrated portfolio of specifically selected Japanese equities".

Investment manager Yuki Watanabe said the fund sought to identify "attractive investment opportunities in the context of long-term structural trends".

He pointed to six trends affecting Japanese stocks, comprising: a shift in demand to higher value-added products, such as companies that provide high technology materials to airlines; rising purchasing power in emerging economies such as China; demographics, such as Japan's ageing society; changing consumption patterns, such as the growing trend towards e-commerce in Japan; growth in infrastructure demand, such as spending driven by the 2020 Tokyo Olympics; and improving corporate governance, which was putting a renewed focus on shareholder returns.

Watanabe said the fund narrowed down its investment universe based on the six key structural trends, to then focus on a company's growth outlook and potential to increase shareholder returns.

"What we're looking for is a virtuous cycle in companies, which not only grow but distribute to shareholders," he said.

He pointed to the potential for further dividend payouts or share buybacks by Japanese companies, which currently are hoarding a collective $1 trillion worth of cash.

Watanabe said Japanese stocks should benefit from tailwinds including diverging monetary policy with the United States which would weaken the yen, improved corporate governance resulting in higher returns on equity, and the BOJ's asset buying.

Japanese public pension funds also have room to increase their Japan equity allocation, he said.

For Australian investors, where the local bourse is dominated by financials and resource stocks, Japan's index has a greater proportion of industrial, IT and consumer discretionary companies, offering both sector-based and international diversification benefits.

"Japan has about 3,500 companies in the listed market to choose from," Watanabe said.

"Also, investing in Japanese equities is not synonymous with investing in Japan--there are companies growing in different segments, which are replicating their domestic success in overseas markets such as China".

Another Japan-related fund, the BetaShares WisdomTree Japan ETF (ASX: HJPN) tracks the performance of the WisdomTree Hedged Japan Equity Index, which provides exposure to the largest dividend-paying Japanese companies that generate at least a portion of their revenues outside Japan, hedged to Australian dollars.

As of 30 September, the fund's top exposures included Toyota Motor, banks Mitsubishi UFJ and Sumitomo Mitsui Financial, and Japan Tobacco.

WisdomTree Japan's Jesper Koll said while the "hype" around Abenomics had diminished, positive structural changes were continuing, including declining corporate cross shareholdings, rising return on equity, an end to deflation, a growing double-income middle class and historic growth in corporate payouts, with 22 trillion-yen worth of buybacks and dividend payments in 2016.

"Japan is no longer a closed club--it has become much more transparent, and that is good news for international investors," he said.

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Anthony Fensom is a Morningstar contributor.

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