Portfolio Adviser • Portfolio Adviser May 2025 • Four views

Despite Japanese equities having experienced a turbulent 12 months, a strong corporate governance reform story is evolving the investment landscape. Portfolio Adviser asks the experts for their prospects of the region moving forward

Theo Wyld: ‘Picking quality stocks with a leading focus on corporate governance today may unlock greater returns tomorrow’

Corporate governance reform continues to gather pace in Japan. Dividends, management buyouts and share buybacks are hitting fresh record highs while cross- shareholdings continue to be unwound more rapidly than ever before.

As the Tokyo Stock Exchange (TSE) continues its push to improve capital efficiency, we expect the trajectory to extend well into the future. Corporate governance reform remains a structural trend in encouraging Japanese corporates to improve returns to shareholders.

The ongoing corporate governance reforms have meant our investable universe continues to expand. There are more than 3,900 companies listed on the TSE with around 100 stocks on our watchlist, which we monitor closely. While they may not meet all of our investment criteria now, these companies have the potential to improve shareholder returns further.

Not only are stocks benefiting from an increase in flows from domestic investors, but the prospect of an improving economic backdrop through monetary policy normalisation and welcome inflation can provide an additional tailwind for Japanese companies.

The key, as Japan continues to adjust to rising prices, is discernment. Picking quality stocks with a leading focus on corporate governance today may unlock greater returns as the nation finds its feet in its new era of inflation tomorrow.

As the emphasis on corporate value generation becomes more deeply ingrained, Japanese companies can deliver value for shareholders over the longer term despite any short-term market noise.

For years, there have been two investment ‘truths’ about Japanese equities: first, that a strong yen equals a weak market; and second, that Japanese companies are not run for shareholders. The combination of these two has made it easy to look for other places to invest. But that might be changing.

The Japanese yen is often talked about as a safe-haven asset – investors buy it when they are scared, which usually isn’t good for equity markets. But the world doesn’t have to be falling apart for the yen to appreciate. For foreign investors, there is the tantalising possibility that you can have strong market returns and strong currency returns – that’s what happened in the US for the past decade.

The reason that might happen is because foreign investors are starting to wake up to the fact that Japanese corporate culture is changing. Two years ago, the TSE told companies to basically make themselves attractive to investors – to start returning money, rather than hoarding it in huge cash piles or complicated investments in other businesses.

The companies that have taken that seriously have done very well, with share prices increasing by an average of 50%, compared with less than 20% gains for businesses refusing to change.

The three largest stockmarkets in the world are the US, China and then Japan. As investors start to worry about the US (and are certainly not going shift everything to China), Japanese equities stand to benefit from the marginal dollar looking for a home.

For the first time in a couple of decades, Japan’s stockmarket story looks really interesting. At 7IM, our neutral position in Japan is nearly 10% of equity exposure, significantly higher than the global index weight of 5%. We don’t see the need to increase further – yet.

Despite the near-term volatility in global financial markets, including Japan, the Japanese equity markets appear to have strong long-term prospects. In addition to hosting some of the best businesses in the world, a number of structural factors should contribute to the performance of Japanese equities.

First, Japan has witnessed a steady improvement in corporate governance and transparency over the past decade. Improved capital allocation has also been supported by increasing interest in Japanese companies by private capital providers – eg private equity and venture capital firms both domestic and global – that can assist in business transformation.

There is strong support from regulatory groups such as the TSE for these kinds of measures, which should also encourage further capital efficiencies and improving returns on invested capital. In addition, valuations of Japanese equities are very attractive. Despite the corporate sector owning some of the most important and valuable intellectual property globally, Japanese equities trade at only 1.5x book value compared with 3.7x for industrialised countries (excluding Japan), which represents a 60% discount.

The combination of high-quality businesses with strengthening returns on capital, improving corporate governance and low valuations support a high potential for Japanese equities over the long term.

James Davies: ‘Shareholder engagement is an area of increasing relevance in Japan’

Japan can be a frustrating place to invest, not least because it often seems to beat to the rhythm of its own drum. But this, of course, can provide exactly the attractive qualities those looking for diversification from their fund choices might hope to exploit. The country provides good exposure to technology, industrial and financial sectors, as well as having a deep and accessible mid- and small-cap market.

Our approach to Japan has been to try and identify fund managers who can benefit from some of the idiosyncrasies on offer from the country at both a company and market level, while capturing some of the valuation discount that Japanese stocks often still enjoy.

The M&G Japan fund (which is held within the TrinityBridge Managed funds), has a long-tenured team who are style agnostic relative the index, but who nonetheless aim to understand the intrinsic value of the companies they invest in.

They make investment decisions on highly researched ideas, which do not rely simply on a myopic focus on financial statements.

As a team they also look to add value through shareholder engagement, which over a decade now has been an area of increasing relevance in Japan. Indeed, corporate reform was also a key reason for our support of the Chikara Japan Income & Growth fund (the investment trust version is owned within the TrinityBridge Managed Income fund).

The Chikara fund looks to benefit from the rising dividend payouts in Japan, which are increasingly being seen as relevant for an ageing country with low yields available on bonds and savings accounts.