Just like European and emerging market equities, Japanese equities have lagged behind US equities year-to-date, amid global political and macroeconomic concerns.
The current state of the global economy remains a key factor in terms of support for the Japanese equity market.
The biggest concerns for the sector now are the escalation of the trade war emanating from the world’s largest trading partners and the uncertain outlook on the Japanese yen.
The yen’s high sensitivity to global events could prove problematic, and any sustained strengthening of the currency represents a potential risk to Japan’s progress.
As the yen is generally regarded as a haven currency, any new crisis or negative event in global markets tends to prompt a sharp appreciation of the yen.
With a high proportion of Japanese companies’ profits coming from exports, a strong currency is less than ideal, as corporate profits would take a hit.
However, global growth, though decelerating this year, is expected to remain stable and continue to lend a supportive growth environment for the Japanese corporates.
Meanwhile, the ongoing progress in corporate governance reform in Japan, along with the deliberate and strategic improvement efforts by Japanese companies to increase their earnings and profitability, are expected to support the recovery of Japanese equities.
Here comes the sun
Japan embodies a very reasonable valuation, positive earnings growth, and a domestic and structural reform story that is driving corporate returns upwards, said T Rowe Price’s Archibald Ciganer.
‘We believe that the valuation case for Japan still holds and that Japanese corporate earnings growth is likely to exceed global peers,’ he said.
Citywire AAA-rated Ciganer, who manages the T Rowe Japanese Equity I EUR fund, sits on top of the Japanese equities category. The fund returned 50.38% over the past three years, compared with the sector average of 25.08%.
Ciganer said the fund invests mainly in changing trends in Japan, such as ageing demographics, labour shortages, and consumption and dietary habits.
Invesco Asset Management’s Tadao Minaguchi said defensive sectors, such as healthcare, utilities and telecommunication services, outperformed, while cyclical sectors, including materials and financials, lagged behind.
Citywire AA-rated Minaguchi manages the Invesco Japanese Equity Advantage A Acc JPY fund, which returned 34.09% over the past three years. The fund took profits from its investments in leading companies across various industries.
This included an electro-optics product maker with competitive advantage in the semiconductor and electronics space, an IT security company with a leading position in both consumer software and enterprise-use security solutions, and a global green tea brand.
In addition, the fund also focuses on franchise quality and free cash flow.
‘We took advantage of the mismatch between the valuation and long-term fundamentals, as well as taking profits from significant outperformers,’ Minaguchi said.
The fund also accumulated positions in companies with attractive cash flow yield valuations.
The times they are a changing
The Nikko AM Japan Dividend Equity SGD Hedged fund is tenth in the category, having returned 20.6% over the past three years.
Nikko Asset Management’s Toshinori Kobayashi, who is rated AA by Citywire, said efforts to improve profitability of Japanese corporates through structural reforms will further support corporate earnings.
‘We expect to continue to see many opportunities to invest in names that, in addition to providing stable dividend income, can offer capital gains, as dividend hikes drive up their share prices,’ he said.
As such, the fund will focus on those names from which sustained dividend growth can be expected, as well as pay close attention to firms where there are indications that management, via business mid-term plans, is changing its stance on shareholder returns.
The fund will primarily focus on domestic demand driven firms, such as IT services, network construction and temporary staffing agencies, as well as outsourcing firms related to government-led initiatives to reform Japanese work culture.
Kobayashi said he also sees opportunities to invest in construction and building materials firms that are expected to see favourable conditions continue ahead of the 2020 Tokyo Olympics, as well as specialty retailers that are expected to see earnings improvement driven by industry restructuring.
‘With regards to export-oriented firms, we plan to focus on names in sectors such as electronic materials and machinery that are highly competitive in niche segments,’ he said.
This article was published in the October issue of the Citywire Private Wealth magazine.