Japan: Small Change Clouds Big Picture

We continue to believe that achieving real economic growth in Japan requires changes that are hard to come by. On a recent trip to Japan, it became clear to me that this next stage of Abenomics — shorthand for Prime Minister Shinzo Abe’s “three-arrow” economic revitalization program of monetary easing, targeted financial support and structural reforms — calls for corporate governance reform to take the spotlight as a core part of the important third arrow, particularly as regulatory reforms have made slow progress thus far.

Paltry ROE disappointing


I had the benefit of hearing Professor Kunio Ito of the Graduate School of Commerce and Management from Hitotsubashi University deliver a speech about his research project for Japan’s Ministry of Economy. The Ito report focuses on corporations’ need to enhance their earnings power, create consistent value for shareholders, and position themselves for consistent long-term returns. We strongly agree with some key recommendations of the report, such as improving shareholder friendliness and incentivizing management through stock ownership.

Disappointingly, the report also sets the minimum level of return on equity (ROE) at a paltry 8%,1 and corporates are taking note. One well-known auto manufacturer I met felt that an 8% ROE is good enough. Strangely, this target is below even the market average for the MSCI Japan Index, projected at 9.7% for the next 12 months.2 By comparison, the ROE for Invesco International Growth Fund is projected to be more than 20% for the same period.

Cautious and underweight

Unfortunately, progress in Japan is as slow as we’ve feared. Through the end of third quarter, Japan was one of the worst-performing markets in Asia, down more than 7% in US dollar terms.3 For some stocks the price correction was even more pronounced, making valuation of some of the higher quality companies more appealing. As a result, we’ve been selectively adding to our Japan weighting — more than 200 basis points through the third quarter. However, our Japanese weighting still represents our largest single-country underweight in Invesco International Growth Fund, and we remain cautious.

As always, we’re carefully watching the markets and adding opportunistically where valuations are attractive. While we’re looking for price dislocations due to macro blips, we remain focused on a bottom-up investment approach of identifying attractive companies that fit our quality growth — or EQV (earnings, quality, valuation) — investment process.

1 Source: Mizuho Industry Report, September 2014

2 Source: FactSet, MSCI. Data as of Sept. 30, 2014

3 Source: Bloomberg L.P., as represented by the Nikkei 225 Index. Data as of Sept. 30, 2014

Important information

Return on equity (ROE) is net income divided by net worth.

An investment in developing/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.

The MSCI Japan Index is an unmanaged index considered representative of Japanese stocks.

A basis point equals 1/100 of 1%.

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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All data provided by Invesco unless otherwise noted.

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