Is it time to take a good hard look at Japanese equities?

Last year, while North American equity funds may not have been the only game in town, they were certainly the biggest. This year is leading many to question the soundness of a market that was hitherto viewed as a one-way bet.

I’ve pointed to the increasingly concentrated nature of the US market and the increasing concentration of investors’ portfolios on that market many times over the past few years. Japan is certainly one way to diversify your portfolio—but is it a good one?

The Japanese market was down over the first four months of the year, though less so than US large caps. Over the first four months of the year, the Investment Association Japan sector is down 1.15%, with last year’s favourite—North America—down 10.12%. That said, over five years the former returned 36.73%, and the latter 74.12%.  For reference, the figures for UK All Companies over the same periods are 1.06% and 47.78%, respectively.

The argument being made for Japanese equities hinges very much around improved governance: particularly, the change in attitude towards shareholders, especially regarding raising return on equity. The Tokyo Stock Exchange has been pressurising Japan’s many capital-inefficient companies—specifically, those with price-to-book ratios below one—to shape up or delist.

Japanese companies are also sitting on large piles of cash compared to their global peers, and there’s increasing pressure to put this to work or return it to shareholders. Either would be attractive to investors, but the growth potential of the former is much talked of.

Things seem to be moving in the right direction: one recent report highlights about 3.8trn yen (£19.7bn) of share buybacks this April alone, more than three-times the level of the previous year.

That positivity has not translated into cash, as the sector has suffered outflows of £2.53bn over the 12 months to the end of April. The two most successful asset gatherers over the period were both passive products—HSBC Japan Index Fund Income S and iShares Japan Equity Index (UK) D Acc GBP—with the perennial favourite M&G Japan Fund coming in third.

The Investment Association folded its Japanese Smaller Companies sector into the Japan sector, so this group now includes funds right across the cap spectrum. As was the case previously, the perception that the Japan performance has been driven by large caps, most funds in the table below have a multi-cap style bias, with one mid cap (Polar Capital) with only one pure large cap (Lazard, as was the case last year) in the running.

In terms of style, eight of the funds on the table have a value tilt, with two (M&G and Quilter) being designated core by Lipper. In terms of three-year returns, value funds have tended to congregate at the top of the table, core in the middle, and the growth funds at the bottom. That of course doesn’t mean that value is intrinsically better than growth, but simply that market conditions have favoured this style over the past three years. Returns ranged from 57.7% to -14.89%, so to repeat my nostrum—fund selection matters.

Regarding the top performer on the table, WS Morant Wright Nippon Yield, you may notice that it lacks Lipper Leader ratings other than capital preservation. This is because the peer group, Equity Japan Income, became too small to calculate ratings. However, the Preservation scores are calculated based on the fund’s asset type, not classification, and so still available. That said, it has a three-year volatility of 2.65, which is lower than for the sector average (3.13), and for the average of the 10 funds on the table (3.02), with the top returns over three years. So, investors have received sector-leading returns at less than average volatility over the period.

Table 1: Top-performing IA Japan funds over three years (with a minimum five-year history)

(Click on image to enlarge)

All data as of April 30, 2025; Calculations in GBP

Source: LSEG Lipper

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