ETFs
Are investors missing a trick by underweighting Japanese ETFs?
Japan has long been neglected by international investors after decades of deflation and economic stagnation left many indifferent to the world’s third-largest economy.
However, the end of eight years of negative interest rates is seen as a victory against deflation and corporate reform has propelled the country’s stock market into the crosshairs of investors.
On average, Japanese stocks account for 3.6% of EMEA investors’ equity allocation in moderate-risk multi-asset portfolios, according to BlackRock, well below their 5.4% weighting in the MSCI ACWI index.
That means many fund selectors have missed much of the recent gains in Japanese stocks. The flagship Nikkei 225 index has returned 47% since the start of 2023, outperforming the United States, Europe and China.
There are signs that investors are catching up. Last month, Japanese stock ETFs saw $6.9 billion in inflows globally, its largest monthly inflows since June 2023, with European investors allocating $1.3 billion, according to BlackRock data.
However, the world’s largest asset manager believes the market still has a way to go.
Corporate reform, foreign investor flows and macroeconomic changes could all prove favorable for Japanese stocks.
Regulatory pressure to strengthen capital improvement plans has led to an increase in stock buybacks, creating a wealth effect that supports consumption, BlackRock said.
At the same time, valuations remain cheap relative to the country’s historical average and relative to pricier U.S. stocks, while much of the stock market’s outperformance appears to be driven by strong earnings.
Analysts revised company earnings upward, expecting year-over-year profit growth of 7.9%.
Chart 1: 12-month forward P/E ratio
Source: BlackRock
The recent decision by the Bank of Japan (BoJ) to raise interest rates for the first time in 2007 – as well as to end the redemption of its ETF program – could be seen as a victory in the battle against its deflationary cycle.
Despite this, concerns have recently increased that inflation will be driven by a weak yen instead of being driven by a spiral of wage growth that would take it towards the policy target of 2%.
However, BlackRock believes that wage growth is moving in the right direction.
“Members of Japan’s largest union group have so far achieved average annual raises of 5.28%, surpassing last year’s 3.8%, which itself was the biggest increase in 30 years.” , indicates the press release.
“Investors should start looking at unhedged exposures to Japanese assets, where possible, and opportunities outside of large-cap exporter stocks.”
Despite the opportunities it could create for investors, the end of the BoJ’s negative interest rate policy could cause some interim volatility.
This has already been felt in the market, with the Nikki 225 index down 6.5% since March 19.
Japanese bonds will likely feel the impact of rising rates, but the BOJ said it would maintain an accommodative monetary policy while continuing to buy long-term bonds.
Inflows of foreign investors and the appetite of domestic investors to invest could also support the country’s stock market.
“Even with the return of foreign investors in 2023, years of persistent selling mean we are just seeing a return to benchmark allocation neutrality in terms of iShares flows and foreign institutional investor flows,” BlackRock said.
“As Japan’s weighting in indices rebalances based on its higher market capitalization, passive investors will need to continue buying Japanese stocks if they want to maintain their allocations.”
Chart 2: Investors are still not overweight
Source: BlackRock
ETFs to consider
For investors looking to increase their exposure to Japanese stocks, there are nearly 80 unhedged ETFs to consider.
The largest ETF on the market is the $5.5 billion one iShares Core MCSI Japan IMI UCITS ETF (SJPA) which has a total expense ratio (TER) of 0.12%. Meanwhile, the Amundi Prime Japan UCITS ETF (PRIJ) is the cheapest on the market with fees of 0.05%.