Japan stock market and funds review – bullish end to the year of the Ox?

Like many other countries around the world, Japan has been on a rollercoaster ride over the last year. A resurgence of the virus in August 2021 meant Japan was forced to extend its state of emergency and tighten restrictions, including banning foreign visitors. This threw Japan’s economic recovery off track.

Towards the end of last year, the economy bounced back though. Large scale vaccination efforts and falling infection rates meant parts of the economy began to reopen. This spearheaded recovery and bolstered consumer spending. Exports rebounded too, thanks to strong foreign demand.

As a result, Japan’s GDP (Gross Domestic Product), grew 5.4% in the fourth quarter of 2021.

Inflation has also been more muted in Japan, compared to some other regions who are experiencing levels not seen in decades. Japanese companies, so far, have managed to avoid passing on costs to consumers, opting to absorb the higher costs themselves. But this isn’t sustainable over the long term.

Japan’s also welcomed in another new Prime Minister (PM), Fumio Kishida. He’s already signalled a clear stance on foreign policy, siding with the US over China, and laid out his plan to help Japan’s economy grow throughout 2022 and beyond.

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Looking ahead

Despite a stronger finish last year, Japan hasn’t had the best start to 2022. The outbreak of Omicron still poses a risk, and the government’s placed restrictions on some areas across the country. Over 80% of the population is now fully vaccinated and over 1 million doses are being administered daily. The country’s in a much better position than prior to the arrival of the Delta variant.

Towards the end of 2021, PM Kishida introduced his new capitalism proposal, which he called ‘a virtuous cycle of growth and distribution of wealth’. His growth strategy is made up of four key pillars:

• Innovation – promoting Japan as a science and technology nation
• Digital Garden City Nation vision – the advancement of Japan’s digital capabilities
• Tackle climate change – through a focus on clean energy and gradual decarbonisation
• Economic security – enhanced support for research and development in cutting edge tech

PM Kishida also unveiled the new budget, coming in at a record-breaking total of $940 billion. He plans to use this money to boost Japan’s pandemic battered economy, help services in need, improve wealth distribution and execute his growth strategy.

There’s still plenty of uncertainty and many challenges to overcome, but there could be light at the end of the tunnel for Japan.

How’s the stock market reacted?

The Japanese stock market saw some strong bursts of performance in 2021. A brighter outlook on Covid-19, the hopes of fresh stimulus from a new Prime Minister and improved vaccine rates helped the Nikkei reach heights not seen in over 30 years.

More recently though, the Japanese market’s lost steam. This was mainly driven by investor concerns following interest rate hikes in the US (and the impact it has on tech stocks). But also the impact of the Omicron variant delaying plans to reopen the economy. These lengthy restrictions have sapped consumer spending and economic growth.

Overall, the Japanese stock market has lagged other global markets over the past 12 months, falling 0.56% over the period.

Japanese stock market vs other global stock markets

Scroll across to see the full chart.

Past performance is not a guide to the future. Source: Lipper IM, to 28/02/2022.

Market ups and downs ahead are likely. Japanese markets face other external pressures, including the Ukraine crisis. The war currently shows no signs of abating, which has meant oil prices and other commodities have surged. Japan is deemed resource scarce and is reliant on importing its energy. Another resurgence in the virus is also a worry, alongside any further delays to reopen the economy.

Despite this though, lots of Japanese companies have reported rising profits and recovery in overseas economies could boost this further. Japanese companies could also benefit from continuing economic support from the Kishida government. Over the long term we expect the market to offer investment opportunities, but it won’t be all plain sailing.

Five year performance of global stock market

Scroll across to see the full chart.

Past performance is not a guide to the future. Source: Lipper IM, to 28/02/2022.

Where are the opportunities for investors?

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.

Historically, corporate governance hasn’t been strong in Japan, with things like board diversity falling short compared to most of the western world. This has started to change. On 4 April 2022, the Japanese stock market is set to restructure into three groups: prime, standard and growth.

This restructuring aims to increase the standards of listed Japanese companies alongside higher standards a company must meet to be included in particular market group. Improvements will mean a clearer Environmental, Social and Governance (ESG) focus, including diversity within companies and better disclosure. This could mean companies are viewed more positively in the market and potentially fuel interest from foreign investors.

PM Kishida has also looked to encourage digital investment. In September 2021, his predecessor Yoshihide Suga, launched a Digital Agency aiming to push digital transformation in both public and private sectors. He wants to enhance this further by creating a ‘Digital Garden City Superhighway’ which should provide access to high-speed digital services anywhere in Japan. He also wants to improve the implementation of drone technologies and autonomous driving.

In terms of Japan’s environmental aims, former PM 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. PM Kishida wants to continue this focus on clean energy by upgrading the nation’s power grid and expanding the use of energy storage technology.

There’s still work to do though. Japan struggles to generate power. To achieve its targets by 2050, it needs thermal power to aid the transition to renewable energy. As a result, Japan didn’t sign an agreement at COP26 to phase out coal. It’s one of the only countries in the G7 building coal fired power stations domestically. But shifting away from thermal power generation in favour of renewable energy is the long-term aim.

Japan – dispelling the myths and uncovering the opportunities

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.

How have our WSL funds performed?

Japanese Wealth Shortlist funds delivered mixed performance over the year as different investment styles came in and out of favour. Funds investing in companies undergoing a turnaround, otherwise known as ‘value’ focused funds, did well. Those investing in companies capable of above-average earnings growth, also known as ‘growth’ funds, took a hit.

One year is a short period to assess the skills of a fund manager. Managers with different strengths, styles and areas of focus will perform differently and all investments can fall as well as rise in value, so you could get back less than you invest. For more details on each fund and its risks, please see the links to their factsheets and key investor information below.

The Man GLG Japan CoreAlpha fund was the best performing fund in the Japan sector of the Wealth Shortlist over the year to the end of February 2022. The fund returned 14.17%*, beating the broader Japanese stock market by 14.73%.

The fund sits at the deep value end of the spectrum and benefited as the style returned to favour with investors. Good stock-picking from manager Jeff Atherton, alongside strong performance in the financials and basic materials sectors, also helped drive the fund’s performance.

Find out more about Man GLG Japan CoreAlpha, including charges

Man GLG Japan CoreAlpha Key Investor Information

On the other hand, the FSSA Japan Focus fund was weaker. It’s a much more growth-focused fund and has naturally struggled amid the value rally, particularly going into 2022, falling almost 20% in the year-to-date.

This is a very short period to judge performance though. Manager Sophia Li doesn’t tend to invest as much in companies more closely linked to the economy, including financial and oil & gas companies. This means she missed out on some of the gains made. Instead, she continues to invest in high-quality companies capable of above-average growth over the long term.

Find out more about FSSA Japan Focus, including charges

FSSA Japan Focus Key Investor Information

We think these funds could dovetail well in a portfolio. One has the potential to do well when the other struggles. Investment styles can fall in and out of favour, but we think both funds have the potential to perform well over the long term.

Past performance is not a guide to the future. Source: *Lipper IM, to 28/02/2022.

How have other Japanese funds performed?

The average fund in the IA Japan sector fell 2.74% over the past year, compared to the 0.56% fall for the FTSE Japan Index*. Remember, past performance isn’t a guide to future returns. Over this period, funds focused on larger, more established companies outperformed those focused on smaller and medium sized companies.

Most Japanese smaller companies are reliant on the health of the Japanese economy. There have been delays in re-opening the economy meaning they haven’t managed to maintain normal levels of business.

Baillie Gifford Japanese Smaller Companies was one of the weakest funds in the IA Japan sector. It’s fallen 25.88% over the past 12 months, partly driven by its bias towards higher-risk smaller companies but also its investments in certain technology businesses.

The next best performing fund, after Man GLG Japan CoreAlpha, was LF Morant Wright Nippon Yield, which returned 14.08%. The fund benefited from the recent value tailwind, along with its investments in industrials which helped drive performance.

Past performance is not a guide to the future. Source: *Lipper IM, to 28/02/2022.

Find out more about Baillie Gifford Japanese Smaller Companies, including charges

Baillie Gifford Japanese Smaller Companies Key Investor Information

Find out more about LF Morant Wright Nippon Yield, including charges

LF Morant Wright Nippon Yield Key Investor Information

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