Japan Equities: Entrenched Perceptions Ignore Improving Reality

Most global equity managers today are underweight Japan. They harbor a view that Japan is a slow growth, low profit, and low return place to invest due to demographic headwinds and a paternalistic corporate system. We believe reforms have driven a rise in profitability and a more shareholder-friendly environment in addition to representing important secular tailwinds. While Japan is and will remain cyclical, we believe investors would do well to revisit their biases and acknowledge that substantive change has occurred. This change has led to better fundamentals than most recognize and bodes well for long-term investors.

Japan profit margins and attitudes toward shareholder interests have improved substantially over the last decade. Investor perceptions of Japan, however, have lagged this progress. In this piece, we touch on the key forces behind this improvement, noting where we see room for additional profit gains and shareholder-friendly outcomes.

Key Takeaways

  • Long-standing corporate, economic, and cultural beliefs in Japan previously favored a broad group of stakeholders above shareholders.
  • Reforms and policies, however, have led to a more shareholder-friendly environment and driven a rise in profitability. These efforts represent important secular tailwinds.
  • Hard to implement operational moves like raising prices, cutting costs, and divesting non-core businesses have driven profit margin expansion and thus improvements in return on equity (ROE). Optimizing bloated balance sheets will pave the way to an easier path to continued gains in ROE.
  • From a top-down perspective, GMO finds Japanese equities quite attractive. In an expensive world, Japanese Small Cap Value rises to the top of attractive securities to own, as we do across our various GMO Asset Allocation strategies.
  • Our Usonian Japan Value portfolios are significantly cheaper than the market yet have stronger balance sheets. We are investing in companies that have both the ability and inclination to increase the distribution of excess capital to shareholders while improving ROE along the way. Active engagement helps the process.