Advisers advocate upside potential for Japan stocks

Asian investment advisers are increasingly suggesting that their clients keep looking to Japanese equities for returns in 2018, but they differ on how best to access the country’s asset class.

The oulook for Japanese equities looks strong due to a mixture of increased certainty in the country’s political situation, loose monetary policies and improving earnings, said country watchers.

“We like Japan,” Gabriel Chan, head of equity advisory for BNP Paribas Wealth Management, told AsianInvestor. “We think that the earnings momentum is still sustainable, and we have very accommodative monetary policy there, particularly after Shinzo Abe won the election again.”

Abe’s landslide victory in the October election gave some relief to global investors, added Daiju Aoki, chief investment officer and Japan economist at UBS Wealth Management. China’s stronger than expected economic growth also had a positive impact on the Japanese market, he told AsianInvestor.

“These events supported Japan equity well, exceeding our initial expectations.”

China’s economy grew by 6.9% in the first three quarters of 2017, according to a World Bank report in December, outpacing the financial institution’s October forecast of 6.7%. The MSCI Japan index is up 23.5% year to date, as of November 30, while the Nikkei 225 benchmark index rose 19.1% across 2017 to December 29.

Japan’s economy had grown for seven consecutive quarters as of the third quarter of 2017, the first time this has happened in 15 years, a December Schroders report noted. However, the investment advisers pointed out that overall market valuations remain attractive relative to their own history and compared to other global markets.

The Nikkei 225 PE ratio was at 14.97 as of December 1, compared to 25.57 for the S&P 500 on December 1 and 19.75 for the MSCI Europe index as of November 30.

The positive momentum and relatively appealing price levels are causing more institutional investors to be interested in Japanese equity, added Masato Mishina said head of institutional sales at Nikko Asset Management. “Interest rates are on an upward trend worldwide, creating challenges in managing excessive risk,” he told AsianInvestor, “and investors looking at Japanese equity have increased this year (late 2017) as a result.”

Selective approach

While Japanese equities have performed well, Bryan Goh, the chief investment officer of private bank Bordier & Cie in Singapore, is more selective in his equity investments.

“There’s still good value there,” he told AsianInvestor. “If you want new economy growth companies leveraging on the Japan recovery, you should go with an active manager or stock pick yourself.”

Goh argued that many components of benchmark indexes such as the Nikkei 225 are old economy companies such as heavy industry, which have less growth potential. As a result, investors that access Japan via exchange-traded funds (ETFs) or large index-hugging mutual funds will necessarily have to include these invesments alongside new economy growth stocks, likely reducing performance.

Active stock picking in Japan is also viable for longer term Japanese equity investing, claimed Stephen Pau, chief investment officer for Hefeng Family Office.

“Some of our investors are more medium to long term,” he told AsianInvestor. “We do pick some of the Japanese stocks, mainly tech stocks, to achieve that. That’s more like a core holding for our clients, in terms of portfolio construction.”

ETF appeal

However, Pau noted that investors looking for a shorter term exposure of up to  six months, for a technical asset allocation for example, would do better to use ETFs.

“You don’t want to get out of the market by selling 50 to 60 stocks,” he said, “so this is the fast exposure to get beta to the Japanese market.”

Lack of familiarity with Japanese companies among investors, as well as rising stock prices, could also make ETFs the better investment choice for investors looking to access the country’s equities, added BNP Paribas’ Chan.

“Clients who are confident about the overall economic outlook of Japan but are not familiar with individual companies may decide to purchase an ETF with [one of] the major indices, such as Nikkei 225, as the underlying instrument,” he said.

The performance of the Nikkei 225 over the course of 2017 means that investors who are concerned about overall market valuation but interested in specific stocks can use ETFs to hedge overall market exposure, Chan explained. “They may establish direct long position in the individual stock,” he said, “but hedge against overall market volatility by entering into a structured product, again using major index ETF as underlying instrument.”

By the numbers, most new investors in the Japan equity market are continuing to enter via ETFs. Around $42 billion worth of equity flows were invested into Japanese funds and ETFs during 2017 as of the end of October, Barbara Ferraresi, director of global market intelligence at financial data firm Broadridge Financial Solutions said. “It is again an ETF story since almost all of it, $41 billion, comes from ETFs,” she told AsianInvestor.

This compares to 2016, when there was around $32 billion in equity inflows into Japan over the same time period, $29 billion of which was funneled into ETFs, according to Broadridge data.

Institutional investors are investing into Japan’s equity market via ETFs and index funds, Nikko’s Mishina confirmed, as well as through Japanese equity neutral, SMEs, and smart beta index interlocking funds.

“Individual investors in Japan are net sellers in stock picking transactions,” UBS’ Aoki added, “while they are net buyers in ETF transactions this year.”

However, this does not necessarily mean investors will remain more interested in ETF purchasing during 2018, he asserted. “Individual investors think the room for further stock price increases is becoming limited,” Aoki said. “We see that they are getting more [interested in] stock pickers rather than purchasing ETFs for these [past] couple of months.”

Ongoing impetus

Looking ahead, Mishina expects interest in Japanese equities to remain high among institutional investors in 2018, as they seek to benefit from the potential ongoing rise of the Nikkei.

Bordier’s Goh was more specific, pointing to Japan’s aging population as an intriguing area of investment. “The aging population theme is very rich,” he said, “because you can mine it from a technology point of view, from a consumer point of view, and from a healthcare point of view.”

Investors are interested in thematic approaches to investing, Aoki agreed, such as investing in companies that will benefit from Japan’s labour shortage issues, as well as the service, retail, machinery, and transportation sectors.

BNP Paribas’ Chan said there are opportunities in Japan’s technology companies. “The tech company sectors actually supply to all the big names that you know,” he said, “but their valuations are half of [those firms], and they are also improving their dividend payment.”

However, cheap valuations aren’t necessarily the deciding factor for investors, Aoki noted. “Investors prefer investing in companies which have strong growing momentum,” he said. Machinery, electric parts and devices outperformed in 2017, and investors expect this positive momentum to continue into 2018.

While Hefeng’s Pau is positive on Japanese equities in 2018  he noted some concern over the country’s lacklustre corporate governance, citing the Kobe Steel data fabrication scandal as a recent example. The Japanese steel manufacturer announced on October 8 that it had falsified its quality control data on aluminium and copper products.

Stagnant wage growth and deflation are also on Pau’s radar, as well possible changes by Japan’s central bank to its currently loose approach to monetary policy.

“If the Bank of Japan reverses the stimulus programme, then probably at the outset, at the beginning, that probably will be a negative for Japanese equities,” he said.