Japan – dispelling the myths and uncovering the opportunities

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All information is correct as at 31 December 2021 unless otherwise stated.

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Japan’s culture is rich and its history deep. Lots of Japanese practices, products and customs are well known all across the globe. But when we look at the country through an investment lens, the picture is a little more distorted.

Investors were scarred by the period known as ‘The Lost Decade'. Japan’s economic bubble burst in the late 1980s to early 1990s, resulting in recession and years of sluggish growth. Many were put off investing. But before this, Japan was the original Asian success story. Throughout most of the 80s, Japanese companies were dominating globally, stock markets were rising quickly, and the Yen reached, at the time, unimaginable heights.

It’s been a long and difficult journey for investors since then. But markets have started to bounce back, and investor interest has been reignited in the economy once more. The country’s home to some of the best-known companies on the planet, including Toyota, Sony and Honda. There are also some lesser-known businesses with the potential to become the household names of tomorrow.

The outlook for Japan is promising, but there’s still work to do. Japan must dispel a few myths and deal with some longstanding trends that could potentially hamper its growth. This has been more challenging over the last few years due to the pandemic, but strides have been made.

This article isn’t personal advice or a recommendation to invest. All investments and any income they produce can fall as well as rise in value, so you could get back less than you invest. If you’re not sure an investment is right for you, ask for financial advice.

Dispelling the myths

Investors are cautious when it comes to investing in Japan. It’s a market people love to hate. But some investors could be missing out on opportunities in Japan purely based on these myths or misconceptions. It could be time to take another look and see whether they hold up in today’s world.

‘Slow economy and dull companies’

Some see Japan’s economy as an area of little growth, with slow moving parts and unexciting companies. Historically, investors were right. Certain business could only be agreed with a physical ‘hanko seal’. And the majority of Japanese companies had conservative mindsets, building large cash piles, rather than paying out to shareholders or re-investing into the company.

Over the last few years though, things have started to change. Governance reforms mean that minimum company standards are being raised, including board independence, English language disclosure and a climate focus. Having a diverse range of backgrounds and cultures within a business is important for long-term sustainable growth.

The ‘boring’ or conservative mindsets of Japanese companies served investors well over the pandemic. Low levels of debt and strong cash reserves meant well over half of companies were able to leave dividends untouched. This wasn’t the case for the west where lots of companies were forced to cut or suspend dividends.

There are still parts of the ‘old economy’ left standing. But it’s much more forward looking, and companies are offering something different compared to other markets.

‘Japan is falling behind in the technology space’

Japan is a leader in many areas of technology. The country has an abundance of innovative and exciting companies focused on automation, artificial intelligence (AI) and other critical electronic components.

Companies like Toyota are pushing forward quickly in the development of electric vehicles. Lasertec is competing well in the semiconductor space and Cinnamon is developing AI that can help deal with some of the labour issues in Japan. Healthcare is also thriving with companies like M3, who aim at digitally simplifying certain healthcare services.

‘A shrinking and ageing population means no growth’

Perhaps one of the more well-known trends in Japan is its demographic issues. Japan has the highest percentage of people over 60 globally. Combine that with a declining population and it’s clear there’s quite a strain on the labour market. Both the Japanese government and companies are trying to find solutions to help combat this.

Companies are also finding it challenging to recruit, and highly skilled workers coming through the ranks are quite scarce. However, the number of workers in Japan is increasing. Lots of this is down to the surge of females joining the workforce. Companies are foregoing the old ways of work and are welcoming in skilled female workers.

Being subject to an ageing population means Japanese companies need to think outside of the box to solve this issue. This sort of mentality spurs change and innovation.

What are the opportunities for investors?

Automation and AI are the two innovative technologies leading the charge. Japan’s manufacturing and industrial sectors require large workforces to operate. The introduction of automation means they’re becoming less reliant on manpower and in some cases are more efficient.

Similarly, AI is helping with more timely tasks. Time spent on things like processing and administration work is being reduced. The healthcare industry is also benefiting. Hospitals are being sterilised and sanitised more efficiently thanks to AI robotic laser technologies.

The Japanese government are backing the influence technology will have on the economy going forward. Japan’s Digital Agency was launched in September 2021 and is expected to push digital transformation in both public and private sectors. Digitising government departments and innovation in cashless payments, healthcare and education could benefit companies across a range of sectors. This could open the door to potential opportunities for investors.

Another area in Japan that holds promise is within Environmental, Social and Governance (ESG) factors. On an environmental front, former Prime Minister Yoshihide Suga set ambitious targets to reduce emissions. Almost 2 trillion Yen has been invested into a Green Innovation Fund to support companies involved in green innovation over the next ten years. For example, Renova is a leading player of renewable energy in Japan and is set to push the expansion in the industry.

Investors could exploit opportunities within the social and governance buckets too. The Japanese government are introducing stock market reforms this year. This will look at increasing the standards of listed Japanese companies alongside a harsher criterion to be added to a particular market. Improvements will mean a clearer ESG focus including diversity within companies and better disclosure. This could mean companies are viewed more positively in the market, fuelling potential interest from foreign investors.

How to invest in Japan

Japan is a highly developed economy and considered to be the most advanced in Asia. This is why you rarely see Japan making up investment strategies focused on Asia. It’s excluded from them and considered a separate strategy entirely. Japanese companies are typically found in the developed market indexes, alongside the UK, Europe, or the US.

While Japan remains off the radar for lots of investors, we think the Japanese stock market is attractively valued. There are still many parts of Japan that are misunderstood and under researched, so there could be some hidden gems of opportunities for investors. Remember though, there are no guarantees and it’s important to take a long-term view.

We believe there are just a handful of fund managers with the potential to outperform the broader Japanese market over the long term. We also think Japanese funds could be used to help diversify a global portfolio focused on long-term growth.

Tracker funds can be a great way to get diverse and low-cost access to a certain market. They aim to track the performance of a stock market index.

Active funds are another way to invest. They're run by a professional investment manager who will try to beat a certain index, instead of just tracking it. They decide which companies, countries and sectors to invest in, depending on where they believe the best opportunities are. This can increase risk though – while there’s potential for the fund to perform better than the index over the long run, the reverse is also true.

Investment ideas

Investing in funds isn’t right for everyone. Investors should only invest if the fund’s objectives are aligned with their own, and there’s a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.

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Man GLG Japan CoreAlpha Equity

The managers invest in large Japanese companies they believe can be bought at a lower share price than their true worth, and sell them when they feel the company and the share price has recovered. Remember though, not all of these companies are guaranteed to make a recovery. It’s a style known as value investing. Their discipline in this approach sets them apart from their peers. The fund invests in a relatively small number of companies. That means each one can have a significant impact on how the fund does, which adds risk.

Find out more about Man GLG Japan CoreAlpha Equity, including charges

Man GLG Japan CoreAlpha Equity Key Investor Information

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FSSA Japan Focus

This fund invests in companies that are dominant in their industries. The managers believe the strength and quality of the companies they own is what drives returns over the long run. They tend to invest in relatively few companies which adds risk. Over 70% of the fund is invested in technology, industrials and healthcare companies. This can change over time, depending on where they find what they believe to be the best opportunities.

Find out more about FSSA Japan Focus, including charges

FSSA Japan Focus Key Investor Information

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iShares Japan Equity Index

This fund aims to match the performance of the FTSE Japan – a broad index of more than 500 companies. It invests in every company in the FTSE Japan Index to make sure they track the index as closely as possible. While it invests more in larger companies, it can invest in higher-risk smaller companies too. It also invests in a range of different sectors, including industrials, consumer discretionary, technology and healthcare. We think it’s a good option for low-cost, broad exposure to the Japanese stock market.

Find out more about iShares Japan Equity Index, including charges

iShares Japan Equity Index Key Investor Information