(0:08) Hello and welcome to the Investment Perspectives podcast from RSMR, the Fund Rating Experts. (0:16) Our podcasts are aimed at professional financial advisors. My name is Katie Sykes, Client Engagement (0:24) and Marketing Manager at RSMR, and each month I chat to one of the team about pertinent (0:29) topics related to investment.
This month, I'm talking to Stuart Smith, Head of Managed (0:36) Portfolio Services at RSMR, and we're going to be discussing investment potential in Japan (0:43) and asking, are you big in Japan? Japan hasn't been a particularly well-loved market over (0:49) the last few decades, but convincing performance in 2023 has well and truly put the cat among (0:56) the pigeons, and all eyes now are on how far this new direction of travel will go. (1:01) Stuart, what's the performance story? Well, in local currency terms, Japan outperformed the US (1:07) market last year, which is quite an unknown fact, but most of that was driven by the currency. So (1:14) at the start of 2023, the Japanese yen was at a level of 130 against the US dollar and actually (1:20) went up to 150 around November time.
As recently as 2020, it was actually close to parity with the (1:26) US dollar at the level of 100. And if we look at the major currencies, only the South African (1:32) rand performed worse than the Japanese yen last year. And if you want definitive proof of that, (1:37) you can consult the esteemed Big Mac Index, which shows that you'll pay $5.69 for a Big Mac (1:44) in the US, but only $3.04 in Japan.
Yeah, the strength of sterling and the US dollar has (1:51) reduced market returns for some investors, but the significant weakening of the yen continues to (1:56) attract foreign investors. For a sterling investor then, over a three-year period, Japan has outperformed (2:02) Asia and emerging markets, but it's still a laggard when it's compared to the UK, Europe and the US. (2:10) What's the forecast, Stuart? Well, in terms of economic growth, the consensus forecast is for 2% (2:15) growth in 2023, but less than 1% in 2024, which may not seem quite so outstanding, but it is actually (2:24) higher than the forecast for the UK and Europe for the same year.
Okay, and what's happening with (2:28) inflation in Japan? Well, for the last 25 years, inflation has largely remained below 2% in Japan, (2:35) but in early 2023, it actually rose above 4%, but has remained well below the heights that we've (2:41) seen in UK and Europe, and particularly the double-digit inflation we've seen in the UK. (2:46) And the Japanese government and central bank are confident that they can soon hit the 2% target (2:52) and maintain it, and this will create a confident backdrop for investors. (2:58) What about interest rates then? Well, interest rates in Japan were actually cut to zero back in (3:03) 1999, so that's well before the GFC, and they've basically stayed there for 25 years.
(3:10) Well, that's incredible. The current level of minus 0.1% was actually reached in 2016, (3:17) so it's safe to say that low inflation and interest rates have become the norm in Japan. (3:22) With the recent increase in inflation, though, there are indications that the interest rate (3:27) pattern does need to change.
Yeah, that's right. The yield (3:30) curve control policy has already been tweaked over the last 12 months, with a 10-year Japanese (3:36) government bond yield of 1%. It's now becoming a reference point rather than a cap, and there (3:42) are many commentators actually suggesting that the cap will be removed altogether.
(3:46) What's the rhetoric? Basically, a structural end to deflation and steady economic growth? (3:53) Well, the Nikkei 225, so the stock market index for the Tokyo Stock Exchange, (3:57) reached its highest level in 1989, so it was around the 39,000 level. But then it began a (4:03) close to 25-year downward trajectory, so actually falling below 10,000 in 2002, and again in 2013. (4:11) And we've actually seen a momentous rebound in recent years, and this has meant that the (4:16) index is now tantalisingly close to the all-time high.
What's happening at a corporate level? (4:22) Well, Prime Minister Kishida is pushing corporate prosperity and incentivising companies to perform (4:28) better. The Nikkei 400 index, which is a collaboration between Nikkei, the Japanese (4:34) exchange group, and the Tokyo Stock Exchange, was actually launched to encourage better corporate (4:39) governance and shareholder value. And companies are scored in this index based on return on equity (4:44) and operating profit, and then that's overlaid with qualitative factors relating back to corporate (4:49) governance and disclosure for the end investor.
Historically, Japanese companies have taken a (4:56) defensive stance, but hoarding cash doesn't maximise returns. The levels of net cash have (5:02) reduced over the last couple of years, and the number of dividends and share buybacks has been (5:07) on the increase as a result. Yeah, it has, and on top of this, the cross-shareholding is now discouraged, (5:15) so with independent management promoted as a way forward.
And from August this year, (5:19) the ratio of female directors must be at least 30% of the total board members. (5:25) Right, that's great. Well, these big shifts in and out of the boardroom will generate improved (5:29) corporate governance and lead to better outcomes, no doubt.
Fund management groups have differing (5:35) investment approaches, but they do collectively recognise the evolution of the backdrop in Japan (5:40) and the unharnessed potential, do they not? Absolutely. The Tokyo Stock Exchange, with (5:47) relation to their corporate governance code, has actually asked companies currently trading at a (5:52) price to book value of less than one, which is around 45% of the index currently, to either (5:58) what they've termed as comply or explain, which basically encourages businesses to act to improve (6:04) their shareholder value. So this should cleanse the pool and improve the overall quality of Japanese (6:10) businesses, which in turn will give the end investor more clarity and improve shareholders' (6:15) returns, enticing both domestic and foreign investors to the market.
We know that foreign (6:21) investment has fluctuated a lot over the years, but what can you tell us about domestic investment? (6:27) Well, the Japanese NISA, which is the equivalent of the UK's ISA, so the Japanese government's (6:33) tax-free stock investment programme for individuals, it's been overhauled basically (6:38) to encourage domestic investors to get back into the market and to drive more investment flows into (6:43) funds and equities. A new growth investment NISA will be launched, the annual limit on the newly (6:48) consolidated NISA will be tripled, and the tax exemption period will be abolished, so lots of (6:53) encouragement for domestic investors. Absolutely.
So you know what I'm going to ask you now, (6:59) are things easy when you're big in Japan? Well, there are obviously risks, certainly the return (7:05) of ultra-low inflation, so will inflation fall from its current levels? Chinese potential (7:11) influence, the Chinese economy is going through a difficult period at the moment, (7:15) and the fluctuation of the currency and particularly any significant strength in the (7:19) Japanese yen versus the other major currencies. There are reassuring signs that Japan is well and (7:24) truly on the up. A tight labour market should encourage wage growth and better balance sheet (7:29) management and improved capital allocation will certainly improve the corporate outlook.
(7:33) And the exponential increase in the number of activist investors in Japan in the last few years (7:38) also adds to the sunny horizon. So as the song says, things will happen while they can, (7:44) things could well be easy when you're big in Japan. Stuart, thanks very much for joining me, (7:49) and thanks to everybody for listening, and we'll see you again next month.
(7:54) Our comments and opinion are intended as general information only and do not constitute advice or (8:00) recommendation. Information is sourced directly from fund managers and websites. Therefore, (8:06) this information is as current as is available at the time of production.
RSMR Portfolio Services (8:12) is wholly owned by Rainer Spencer Mills Research Ltd and is authorised by the Financial Conduct (8:17) Authority. The value of investments can go down as well as up.
