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Why we think you should take a second look at investing in Japan

Dominic Rowles explores three key points of why you shouldn’t overlook Japanese companies.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Dominic Rowles, Investment Analyst

Published on 24 February 2020

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

Successful investors don’t just follow the crowd. They scratch beneath the surface to find opportunities others have overlooked.

At first glance, Japan might not seem like a great investment opportunity. The country is engaged in a trade spat with the US, national debt remains high and a recent tax increase on spending has the potential to drag on economic growth.

But the Japanese economy's made huge advances in recent years. Following years of deflation, prices are rising again and unemployment is extremely low. The country's also slowly embracing immigration which could inject some much needed youth into its rapidly ageing population.

Below we look at three of the main reasons you should think about investing in Japan and suggest a way to gain exposure to a wide range of companies at low cost.

This article isn’t personal advice. If you’re not sure if an investment is right for you, please seek advice. Please remember all investments can fall as well as rise in value so you could get back less than you invest.

1. World-leading companies

Japan is home to some of the best-known businesses on the planet. Household names like Toyota, Honda, Sony and Nintendo. There are also a number of innovative higher-risk small and medium-sized companies with the potential to be tomorrow's stock market giants.

We think lots of Japanese companies can make great returns for shareholders, although as with all investments there are no guarantees.

2. Shinzō Abe is good for business

The Japanese stock market has been on a strong run since the election of their Prime Minister Shinzō Abe in December 2012. The Prime Minister quickly set about reviving Japan’s flagging economy with a number of policies aimed at kick-starting growth and encouraging investment. And the new policies seem to be working – the stock market’s grown 121.9%* since 26 December 2012. Past performance is not a guide to the future.

He’s also introduced a Corporate Governance Code which is aimed at encouraging company management to become more shareholder-friendly. For example, just 20% of Japanese companies provided share-based incentivisation for senior managers in 2015. That number's now more than 70%, meaning the interests of management are increasingly aligned with shareholders.

Japanese corporate governance was in the headlines for the wrong reasons last month as the government announced plans to tighten rules over foreign influence on companies deemed important to national security. However, they later clarified that the impact on investors is likely to be limited.

Japan still has some work to do when it comes to corporate governance. And it’ll take time for Abe's improvements to filter through. But they have the potential to make a positive impact on shareholder returns in the long run.

See our latest sector review on Japan

3. The stock market's attractively valued

Share prices of Japanese companies have risen strongly in recent years but their earnings have risen even faster. We think companies' share prices are linked to their earnings in the long run so there could be more growth to come, although there are no guarantees.

Our analysis suggests Japan's home to one of the most attractively valued major markets. The chart below shows our favourite measure of value – the Cyclically Adjusted Price to Earnings ratio (CAPE) for the Japanese stock market, along with the average over time. The market's current CAPE ratio is well-below its long term average level. Ratios shouldn’t be looked at in isolation.

Value in Japan

Past performance is not a guide to the future. Source: Hargreaves Lansdown to 31/01/2020

The CAPE ratio explained

A PE, or price-to-earnings ratio measures how much investors are willing to pay for a company’s earnings (or those of an entire sector or stock market). It’s calculated by dividing the value of a company’s shares by its earnings. But rather than focus on a single year’s earnings, the CAPE ratio takes an average over the past ten years in order to smooth out fluctuations in the economic or profit cycle.

How we use CAPE

We then compare the CAPE ratio with its long-term average to assess whether an area is cheap or expensive relative to its history. It doesn’t tell you exactly when to buy or sell – a market that looks expensive can get more expensive still and vice versa – but to invest at a lower valuation could improve the potential for attractive long-term returns.

A low-cost way to take advantage

The iShares Japan Equity Index fund aims to track the performance of the FTSE Japan index. And with over 500 companies, there's plenty of diversification.

Car makers, banks and electronics are the biggest sectors in the Japanese market, so they form a large part of the fund. But it also invests in small and medium-sized higher-risk companies with significant growth potential.

This fund is our favourite way to invest broadly across Japan. The net ongoing charge is 0.08% annually with HL. Our platform charge (maximum 0.45% per year) also applies.

Annual percentage growth
	Jan 15 - Jan 16	Jan 16 - Jan 17	Jan 17 - Jan 18	Jan 18 - Jan 19	Jan 19 - Jan 20
iShares Japan Equity Index	4.7%	31.9%	12.1%	-5.1%	8.9%
FTSE Japan	5.3%	31.0%	11.7%	-4.5%	10.5%

Past performance is not a guide to the future. Source: *Lipper IM to 31/01/2020

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