Japan stock market and funds review – on the road to recovery?

The pandemic caused global upset throughout 2020. It forced countries into rapid change and forced weaknesses in both economies and societies around the world to the surface.

Japan was already struggling with pressure on the economy and slow growth. The pandemic added to concerns, highlighting areas where it lacked progression and flexibility.

Yoshihide Suga’s appointment as Prime Minister in September 2020 offered hope and promises of fresh and progressive government policies, continued support for the economy and vows to beat the virus. While he’s made some positive steps, he’s not escaped criticism, facing backlash around the fate of the Olympics and delayed response to the vaccine. This resulted in a drop of around 30% to his initial support rate.

That said, Japan has controlled the virus better than most western countries, like the UK and US for example. Covid-19 cases have been kept remarkably low, helped by an efficient healthcare system, the willingness of people to follow government instructions, and strong social norms around hygiene and mask wearing.

This article isn’t personal advice. If you're not sure an investment is right for you, ask for financial advice. Investments will rise and fall in value, so you could get back less than you invest.

How has Japan’s economy fared?

Japan was initially hit hard by the pandemic as global supply disruptions, combined with weak demand for Japanese goods and services, contributed to its worst economic performance since 1955.

Growth in the economy did manage to rebound in the latter part of 2020. Since our last review six months ago, Japan’s GDP (Gross Domestic Product) had two of the strongest periods of growth for almost 25 years.

The final six months of 2020 saw double digit growth, mainly driven by an increase in Japanese exports. Quicker recoveries in China and South Korea meant there was more demand for Japanese goods from these areas. This helped boost exports by 52.3%.

Overall, Japan’s full year GDP fell by 4.8%, making it the largest drop since 2009. This was still one of the more resilient numbers globally though, buoyed by performance in the latter half of 2020 and government intervention.

The Japanese government increased their spending to $1.6 trillion for 2020. A further $1.03 trillion was recently approved for the 2021 Budget too. This should help fund the efforts in grappling the virus and help towards reinvigorating growth. It’ll also be aimed at supporting an ageing population and new investments in digital and green technologies.

The Bank of Japan (BOJ) also offered lots of monetary support for the Japanese economy through quantitative easing (QE).

Quantitative easing is where the central bank creates new money to buy government and corporate bonds in the open market. The idea is to support the price of bonds and thereby reduce interest rates, because yields fall as prices rise. Lower interest rates are intended to stimulate spending and investment as saving becomes relatively less attractive. QE also adds more cash to the system, which can give banks greater liquidity.

For now, the BOJ will hold off on any other changes to monetary policy but will put further measures in place if needed.

Japan’s road to recovery

Japan still has significant challenges ahead of it. Its public debt, for example, is now more than twice the size of its economy, with no concrete plan on how it will be cleared. This isn’t only a problem for Japan. But there needs to be a solution for once the pandemic eases, as it could hinder any recovery in the economy.

The nationwide state of emergency declared in January is also likely to hamper recovery. Parts of Japan were forced to close to prevent a resurgence of the virus. The economy is expected to shrink slightly in the first three months of 2021, as business activity is restricted and consumer spending is reigned in.

Some areas of Japan managed to reduce Covid cases enough for restrictions to be lifted in February. But for Tokyo and three surrounding districts, cases remained high and a two-week extension was required. The government decided, as of 22 March, to lift the restrictions, despite concerns around a rebound in Covid cases. This decision could help provide a boost to the economy or result in a resurgence of the virus, only time will tell.

Vaccination rollouts will play a key part in easing these concerns and aid in Japan’s recovery efforts. Having more people vaccinated will reduce the strain on healthcare resources and safety concerns around the ageing population, but also help limit the spread of the virus. It could also increase the likelihood of going ahead with the Olympic Games, which could help boost the economy.

It’ll take time before Japan’s economy has fully recovered but it’s expected to reach pre-Covid levels by 2022. Government support and the vaccination programme will play an important part in this. There is also optimism around potentially rising above pre-Covid levels, but it’s too early to know for certain.

How has the stock market reacted?

Last year, lots of investors focused on the stellar performances of US growth and technology stocks. Meanwhile, Japanese markets slipped under the radar and silently powered ahead, generating some impressive numbers.

The broader Japanese stock market climbed to heights not seen for 30 years. It was boosted by a weaker yen, expectations of the development and rollout of vaccines, and hopes for government stimulus.

Looking at different sectors, utilities, financials and oil and gas all performed poorly. Whereas, telecommunications and technology were the star performers, as demand for online connectivity, remote entertainment, tele-healthcare and internet-based services rose.

The technology sector could continue to see an increase in demand following the government’s plans for Japan’s digital transformation. The aim is to create an infrastructure that will digitise the entire society innovating things like cashless payments, healthcare and education. This could benefit companies across a range of sectors, providing more opportunities for investors. Although nothing is guaranteed.

Remember, past performance is not a guide to future returns. All investments can fall as well as rise in value, so you could get back less than you invest.

How have Japanese funds performed?

Over the past 12 months, (to 28 February 2021) the average fund in the IA Japan sector returned 23.9%, compared to 18.0% for the FTSE Japan Index*. As always, past performance is not a guide to future returns.

Larger companies outperformed smaller and medium-sized companies, benefitting funds investing more in larger companies.

Funds with a focus on companies capable of above-average earnings growth, otherwise known as 'growth' investing, did best. This means funds like Legg Mason IF Japan Equity, Baillie Gifford Japanese Smaller Companies and FSSA Japan Focus were among the best performers.

Value-focused funds, which often invest in companies undergoing a turnaround, and those that invest less in technology and more in financials, didn’t perform as well.

But in recent months, value-focused funds have performed better. It’s a reminder that investment styles come in and out of favour, and that investors should hold a diversified portfolio. That means having a mix of investments styles, with investments across a range of sectors and from different parts of the world.

Annual Percentage Growth

Past performance isn't a guide to the future. Source: *Lipper IM to 28/02/2021.

Find out more about Legg Mason IF Japan Equity, including charges

Legg Mason IF Japan Equity Key Investor Information

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

Baillie Gifford Japanese Smaller Companies Key Investor Information

Find out more about FSSA Japan Focus, including charges

FSSA Japan Focus Key Investor Information

How have our Wealth Shortlist funds performed?

Japanese funds on the Wealth Shortlist delivered mixed performances over the year. We usually expect this though, because it's in line with how we select funds. If all funds in each sector perform well at the same time, they're probably investing in similar areas. Those same areas won't perform well all the time, so it can be painful when they're out of favour.

The best-performing Wealth Shortlist Japan fund was FSSA Japan Focus, which returned an impressive 43.3% over the past 12 months*. Sophia Li and her team target high quality companies that are dominant in their industry. They believe the strength and quality in the companies they own is what drives returns over the long run. But also helps shelter investors’ capital in periods where the market doesn’t do so well. We like how the fund has reacted in volatile markets. Remember though, past performance is not a guide to future returns.

The fund invests across a diverse range of sectors including food retailing, drugstores and medical equipment. These are essential, regardless of how well the economy is doing. Li saw the market ups and downs in 2020 as an opportunity to add to investments in higher-quality companies at lower share prices.

Man GLG Japan CoreAlpha returned 7.9%*. Jeff Atherton, who has 30 years’ experience investing in Japan, took over as the fund’s lead manager in January 2021, having been co-manager since 2011. Atherton buys out-of-favour companies and waits for them to potentially recover. When he and the team feel the recovery is complete, or a better opportunity emerges, they'll sell and move on to the next investment. It's a style known as 'value' investing.

It means the fund didn’t perform as well last year, but it’s done better in recent months as value investing has returned to favour. Atherton is an experienced Japanese fund manager and we think the fund has good growth potential over the long term, but there are no guarantees.

The iShares Japan Equity Index Fund is a ‘passive’ index tracker fund. The managers look to match the performance of the broader Japanese stock market, rather than try to beat it. The fund invests in just over 500 companies meaning it’s well diversified. As it’s simply tracking the wider Japanese stock market, the managers aim to keep the costs as low as possible.

Here’s how our Wealth Shortlist funds have done over the previous five years. For more details on each fund and its risks, please see the links to their factsheets and key investor information below.

Annual percentage growth

Past performance isn't a guide to the future. Source: *Lipper IM to 28/02/2021.

Find out more about FSSA Japan Focus, including charges

FSSA Japan Focus Key Investor Information

Find out more about iShares Japan Equity Index, including charges

iShares Japan Equity Index Key Investor Information

Find out more about Man GLG Japan CoreAlpha, including charges

Man GLG Japan CoreAlpha Key Investor Information