Japan is a multi-dimensional tale. To some, it is cautionary. To others, it is about missed opportunities. The story of the Japanese asset price bubble starts in the early 1980s. Everyone investing in Japan believed that there was an infallibility to the Nikkei and to Japanese land. Between 1985 and 1991, commercial land prices rose 302.9%. In the years between 1986 and 1989, the Nikkei returned 43.85%, 14.58%, 39.86% and 29.04% respectively. There was overconsumption, overconfidence and in retrospect massively overvalued assets.

The market peaked at the end of December 1989 when the Nikkei reached 38,917. The asset price bubble burst. What followed was an excruciating tumble that continued until 2009. The consequences of the bubble bursting were severe and drawn out. Japan had next to no economic growth even while maintaining low interest rates and inflation. There were several glimmers of hope for a recovery along the way, but the Nikkei was anchored. In the 34 years and counting the market has never recovered to the high reached in December 1989.

Japan's recovery

Figure 1: Japan's 30 year recover (and we're not there yet)

Global investors increasingly avoided Japan as the collapse lingered. Investors saw most Japanese companies had poor balance sheets due to the asset price falls and were struggling to strengthen their financial position. Many of these companies had been burnt and did not want to take on any business risk. They stagnated.

Things slowly began to change. Part of the rising success of Japanese companies has been attributed to Shinzo Abe’s corporate governance code that was introduced in 2014. It forced companies to act in shareholders’ best interests instead of holding onto subpar assets and hoarding cash. This has helped with profitability, along with improving economic conditions.
Many global value managers have been touting the attractive buying opportunities in Japan for over a decade, including Morningstar Investment Management. This article from 2018 reflects the positive prospects that many value managers were eyeing as regulatory risk decreased.

Senior Portfolio Manager Bryce Anderson says Morningstar Investment Management has had a position in Japan for quite some time. 10 years ago, they started seeing the corporate governance improvements that showed great value with manageable risk.

In 2011, Data from Chuo Mitsui International showed that 66% of Japanese firms were trading at a Price to Book ratio of less than 1. In 2009 during the Global Financial Crisis, it was 75% of companies.

In the last 10 years, the Nikkei has outperformed the ASX/200. If you had invested $100,000 in July of 2008, and $1,000 every month from there, you would have close to $450,000 from the Nikkei 225. An investment in the ASX would have resulted in $320,000.

The opportunity cost of investing in Japan

Figure 2: The opportunity cost of investing in Japan

This outperformance was supercharged this year. The Nikkei 225 is up almost 25% year to date.

What can we learn from this global outlier? Many investors have felt they have missed the boat on the gains. The opportunity cost of investing in Japan when it was attractively priced means that investors had much to gain.

Lesson 1: Why being a contrarian investor may reap rewards 

It’s uncontroversial to say that taking an outsized position in Japan in the 20 years following 1989 would have made you a contrarian. Being contrarian is hard because you lose the validation that comes from traveling with the herd. It is human nature to seek validation, especially as investing your hard-earned money is an inherently emotional endeavour. 

Contrarian investors can be rewarded handsomely. The secret to investing is not to follow the crowd but to anticipate where the crowd is going next. If that sounds hard, it is because it is hard.

Being a contrarian investor is at the heart of value investing. It means investing in unloved assets that the crowd is straying away from. There is no better description of Japanese assets during the last two decades. 

Margin of safety

Purchasing assets at lower prices means that there is greater potential for returns, and therefore less risk. This of course, works out well if the asset in question is a quality asset. This was the issue with Japan. 

There were regulatory and market risks impacting Japanese companies. These risks lead to uncertainty of cash flows. Some companies are riskier than others. Take for example two vastly different companies.

We don’t know how much Coca-Cola is going to make next year. But there are some things we do know.  Coca-Cola isn’t going to double its sales next year. Their sales next year also aren’t going to fall by half. They aren’t going to go out of business. They are a mature company that is in good financial shape. 

Next, let’s take a hypothetical start-up mining company in WA. They’ve purchased land that may or may not have lithium. They have some funding and no sales – there’s nothing to sell yet. They need to dig something up in the next year to sell or they will run out of money. Their cash flows may be zero and they may go out of business- or they might strike the motherload and make a fortune. The point is that their cash flows are more uncertain, so investors need to account for this by having a bigger margin of safety. 

Lesson 2: Understanding risk and reward

Part of understanding the trade-off between risk and reward is understanding the full spectrum of risks that impact a company. A like for like investment in an Australian company would not carry the same risk as one in Japan. 

Poor balance sheets aside, there were issues with transparency in Japan. Until relatively recently, Japanese r company results and records were not afforded the same transparency as listed companies in most of the developed world. It was difficult for investors to understand the true positions of these companies. This was particularly difficult for foreign investors as there was no stipulations for the language of the public reporting – they were often in Japanese.

One of the keys to successful investing is understanding what you are investing in. This allows each investor to understand whether an asset is right for each portfolio and to achieve individual financial goals. It also prevents poor investor behaviour by increasing confidence.

This was not possible in Japan until reforms to corporate governance and stock market operations changed the landscape of Japanese companies and equity markets to become investor friendly.

As shown in the graph above (Figure 2), investors were rewarded for the risk that they took on in Japan in money weighted returns, especially compared to domestic equities. Now that these assets have appreciated, they have become less attractive for the risk that they carry. Asset managers like Morningstar Investment Management have trimmed their position. Bryce Anderson adds that after the investor excitement, valuations have become less attractive, and they have reduced their exposure to Japan. 

Lesson 3: You don’t have to pledge to a single church

There are many investing churches. Value vs growth. Active vs passive. Technical vs fundamental. Dollar-cost averaging vs lump sum. I could go on and on, but this lesson is about the push and pull between strategic and tactical asset allocation.

Strategic asset allocation is your long-term asset allocation target. That is the process of defining your goal, calculating your required rate of return and then figuring out how to allocate assets to get that return. This process may lead an investor to decide on an allocation of 90% growth assets and 10% cash to achieve a goal. Part of the 90% in growth assets would be an allocation to international equities, and part of this international equities exposure would be to Japan. Meanwhile a tactical asset allocation may be a short-term deviation from this strategic asset allocation that is made based on market conditions. This would be increasing exposure to Japan because of a belief in the prospects for the region, and/or that it is currently undervalued.

Making a tactical asset allocation decision should not be done lightly because regardless of the rationale, this is market timing. However, investors can take advantage of undervalued opportunities given the circumstances – they have liquidity, they are not deviating too far from their strategic asset allocation and they have the time horizon required for the investments that they are investing in.

In many cases a tactical allocation decision involves cash. An average investor is probably not going to move 2% of their portfolio from listed property to infrastructure because they see some anomaly in the relative positioning of those two asset classes. Similarly, an Australian investor’s international exposure is not likely to be invested by individual geography, and they likely don’t have the ability to pick and choose between weighting these exposures. It is more likely somebody might invest extra cash in shares or broad-based ETFs if they see an opportunity or build up a bit of cash if they don’t see opportunities. 

As an investor, this is an underrated aspect of cash. Having some cash in your portfolio allows you to take advantage of opportunities. Just like having an emergency fund ensures you don’t have to sell shares when it doesn’t make sense.  Having some cash in your portfolio means that you can buy shares when they are on sale. This is an investing lesson within itself.

Warren Buffett said investing is simple, not easy. The simplicity comes from acquiring quality assets at a cheap price. The not easy comes in when you must determine what is a quality asset, the value, its price, and its prospects. Having uncertainty in one’s portfolio is inevitable when investing in equity markets. Investors can utilise margins of safety to protect themselves when taking advantage of opportunities.

Where do we see unloved assets?


Morningstar’s Fair Value estimate helps investors understand whether a stock, or a market, is undervalued. When looking at markets, it takes the fair value of our overall coverage to provide investors with a bottom-up value. This helps them see past the current market price.

You’re able to see our fair value estimates for markets in our Market Centre. We currently see domestic and US markets close to fairly valued. Asian markets such as Singapore and China appear undervalued. Fair Value estimates also indicate opportunities in some European markets including the UK and Italy.