Through the second quarter of 2013, Japan remained Invesco International Growth Fund’s largest underweight versus the Custom International Growth Index because our EQV (earnings, quality and valuation) discipline criteria drive us toward high-quality companies at reasonable valuations, and those are scarce in Japan. Why? Because Prime Minister Shinzo Abe’s success is being priced in, and overcoming two decades lost to stagnation is difficult. Achieving real economic growth requires changes that are hard to implement, as discussed in Rx for Japan: Cure Structural Issues.
Prime Minister Abe’s party now controls both houses of parliament after a recent election —a victory that should allow him to push through some reforms. But his position within his coalition requires him to make political concessions, which will likely hamper structural and political reform in areas such as labor, taxes or social security that call into question the sustainability of Japanese growth.
Japan’s shareholder returns remain anemic, and Japanese companies are still focusing more on balance sheet size, and less on profitability. Valuations are overly optimistic. Compared with the rest of the world, Japan has lower expected returns while valuations are similar.
Triggers for a turnaround
For us to have a more constructive take on Japanese equities, we are looking for several changes.
- First, we need to see corporate investment to drive the Japanese economy.
- Japanese companies tend to hoard cash on their balance sheets, which drives down return on equity. Shifting focus from balance sheet size to earnings and profitability is critical.
- While there’s been small but incremental positive movement in share buybacks, a significant trend in buybacks is desirable.
- Additionally, valuations must be attractive. Currently, they’re pricing in unrealistically favorable numbers that reflect reforms that have yet to — and may very well not — occur.
All that said, there are opportunities, but they are few and far between. An example is Fanuc — a 1.32% holding of Invesco International Growth Fund as of June 30, 2013 — a Japanese company that focuses on factory automation, which allows companies to reduce labor costs at a time when the price of labor is increasing — we think there’s a strong, sustainable, long-term growth story.1 In addition, the technological complexity of what Fanuc does makes it difficult for competitors to replicate, which we believe affords Fanuc a defensible market share, as well as a potential long-term growth story. Finally, Fanuc’s valuation is attractive.
The bottom line in Japan: It’s not about Japan versus another country; it’s about finding high-quality companies trading at more attractive valuations than we can find elsewhere.
1 Holdings are subject to change and are not buy/sell recommendations.
About risk
Depositary receipts involve many of the same risks as a direct investment in foreign securities, and issuers of certain depositary receipts are under no obligation to distribute shareholder communications to the holders or to pass through to them any voting rights.
Derivatives may be more volatile and less liquid than traditional investments and are subject to market, interest rate, credit, leverage, counterparty and management risks. An investment in a derivative could lose more than the cash amount invested.
An investment in emerging market countries carries greater risks compared to more developed economies.
The risks of investing in securities of foreign issuers can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified funds.
Growth stocks tend to be more sensitive to changes in their earnings and can be more volatile.
Many countries in the European Union are susceptible to high economic risks associated with high levels of debt, notably due to investments in sovereign debts of European countries such as Greece, Italy and Spain.
The investment techniques and risk analysis used by portfolio managers may not produce desired results.
Stocks of small and mid-sized companies tend to be more vulnerable to adverse developments, may be more volatile, and may be illiquid or restricted as to resale.
The Custom International Growth Index is an index comprised of the MSCI EAFE Growth Index through Feb. 28, 2013 and the MSCI All Country World ex-US Growth Index thereafter. The MSCI EAFE Growth Index is an unmanaged index considered representative of growth stocks of Europe, Australasia and the Far East. The MSCI All Country World ex-US Index is an unmanaged index considered representative of developed and emerging market stock markets, excluding the US.
Before investing, investors should carefully read the prospectus and/or summary prospectus and carefully consider the investment objectives, risks, charges and expenses. For this and more complete information about the fund(s), investors should ask their advisors for a prospectus/summary prospectus or visit invesco.com/fundprospectus.
The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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