With the US representing the lion’s share of the MSCI World index (currently 73%), the Japanese stock market might be on the radar of developed market investors looking to increase diversification and exposure to other markets.
In the first half of 2024, 34 years after its last peak, the Nikkei 225 stock market index reached a new all-time high, which was met with much optimism from investors.
Since then, performance has plateaued and divergence in interest rate policy between Japan and the US has made for notable equity market volatility in the past year. Threats of tariffs from the US president will also be on the mind of investors given that Japan is a large exporter to the US, particularly the auto industry. However, there are a host of reasons why investors can remain optimistic about the outlook for the Japanese stock market in 2025.
First, for those unfamiliar with the story, improving corporate governance remains a key focus of the Tokyo Stock Exchange. The threat of being delisted from the index if your company has a price-to-book ratio (P/B) of less than one, has driven increased share buybacks and encouraged corporates to focus on maintaining and delivering shareholder value. A P/B ratio below one indicates that a stock is priced by the market at a level below the sum of the total assets of the company. Those that fall into this criteria are required to disclose policies and specific initiatives for investment.
Turning to the macro, Japan has finally emerged from an extended period of deflation, with signs of domestic and core inflation picking up. For most countries, an uptick in inflation late in the business cycle would be a concern. However, there’s a view in Japan that the end of the deflation rut is likely to be a positive boost for corporate profitability. Wage growth, which has historically been stifled, is also back in the region, and 5% is the baseline target set for 2025 by Rengo, the nation’s largest union. Rising wages are likely to increase consumer spending, offering a further potential boost for corporates.
Many global investors remain under-exposed to Japanese equities, and if this turns around it could act as catalyst for further market appreciation as more capital flows in. In his recent annual letter to shareholders, Warren Buffett committed to his firm’s Japanese investments for the long term and has reached an agreement with the companies to own beyond the initial 10% ceiling.
One highly rated option for investors in this region is JPMorgan Japanese Ord (LSE:JFJ), a recent addition to ii’s Super 60 list of investment ideas. The trust gives investors access to a portfolio of high-quality companies that aim to compound their earnings sustainably over the long term. The investment trust is managed by the experienced duo of Nicholas Weindling and Miyako Urabe who are supported by a well-resourced investment team which includes 11 portfolio managers and 15 sector analysts.
What does the trust invest in?
The team seeks to tap into the long-term story of Japan’s structural economic transformation by investing in high-quality innovative companies in sectors such as robotics, materials, healthcare, e-commerce and business services, as well as companies transitioning to more capital-efficient business models. Management can invest in opportunities across the market-cap spectrum, although there is a strong bias towards the large-cap space which accounts for over 75% of the portfolio.
This unconstrained quality/growth strategy seeks to identify next-generation market leaders that can double/triple in value over the next two to three years. Around 400 stocks are under coverage. They are classified as either premium, quality, standard or challenged and subject to a valuation analysis based on their expected five-year return. Around 80% of the portfolio is composed of stocks rated premium or quality.
The result is a concentrated, conviction-driven portfolio, currently with 58 holdings and an active share consistently above 80% against the TOPIX. Active share is a measure of how different a fund is from its benchmark. The 80% level is considered high, meaning the holdings are significantly different from the benchmark index.
Management focuses on the highest-conviction ideas from the team and are often willing to pay high multiples for them. As such, the portfolio’s price-to-earnings (P/E) ratio of 19.7x is markedly higher than the TOPIX, which stands at 14.2x.
The managers take advantage of the closed-ended structure by using gearing (maximum of 20%) and holding less-liquid, small-cap opportunities which bring an additional dimension to the portfolio.
How has the trust performed?
Over a 10-year period this tried-and-tested strategy has handed investors an annualised 9.5% return, outpacing the TOPIX, which has delivered 8% over the same period. JFJ suffered a notable decline in 2021 as growth-focused stocks sold off, triggered by rising interest rates across Japan’s developed market peers.
More recently, the trust’s returns have been strong. The structural changes of the economy identified by management have begun to play out, having a direct impact on company fundamentals. Strong earnings and revenue growth has been a theme across the portfolio. This has occurred during a period of weakness across broader market benchmarks in Japan, driven by its more cyclical exposure.
| Investment | 01/03/2024 – 28/02/2025 | 01/03/2023 – 28/02/2024 | 01/03/2022 – 28/02/2023 | 01/03/2021 – 28/02/2022 | 01/03/2020 – 28/02/2021 |
| JPMorgan Japanese Ord | 11.8 | 12.2 | -7.3 | -20.9 | 72.0 |
| TOPIX TR JPY | 2.4 | 18.9 | 1.7 | -0.4 | 16.9 |
Source: Morningstar (Market Return) GBP to 28/02/2025. Past performance is not a guide to future performance.
Over the past 12 months, standout contributors have emerged from a variety of industries. Worth noting are the IT service provider Hitachi Limited andASICS Corporation a footwear brand, both of which have benefited from ongoing structural developments in Japan and management restructuring that has enhanced profitability, cash flow, and earnings. Both companies have experienced rapid share price growth over the past year and are now the top two positions with portfolio weights of 6.7% and 5.6% respectively.
Why do we recommend this trust?
This trust benefits from a proven investment strategy, focusing on high-quality growth businesses, led by a strong management team. The research analysts on the ground in Japan offer an excellent coverage of the market, adding an advantage in stock selection over peers in this sector.
The trust has a tiered management fee, meaning the charge to investors falls as asset levels rise. The yearly ongoing charge for the last financial year equated to 0.73%, remaining competitive within the sector. Long-term investors may also view the current discount of 8.8% as an attractive entry point.
Despite the tailwinds previously mentioned, Japanese valuations remain reasonable and attractive versus global peers. Both the P/E of 14.2 and 1.4 P/B ratio are below the long-term averages for the TOPIX, leaving plenty of room for further re-rating should the improving fundamentals from Japanese companies continue and stability among global markets prevail.
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