Since Japan's economic bubble burst in the early 1990s, Japanese equites have seen extended periods of under-performance. A glimmer of hope emerged when Shinzo Abe was elected Prime Minister in 2012 with his "three arrows" economic policy, which was based on monetary easing, fiscal stimulus and structural reforms. The first two arrows were quickly deployed and the market reacted positively. The Nikkei and Topix indices almost doubled between 2013 and 2015. The third arrow on structural reform has taken much longer to implement, though. 

Almost a decade later, Japanese companies are finally renewing their focus on corporate governance reform, reminiscent of Abe's third arrow. As a result, the country's major stock indices recently hit new multi-decade highs in local currency terms.

This makes it an opportune time for investors to reassess their exposure to Japanese equities, according to a recent article by TD Asset Management Inc. called The rebound of Japanese equities: how investors can navigate the tricky market.

The reforms

The Tokyo Stock Exchange (TSE) is comprised of three market segments: Prime, Standard and Growth. The Prime section of the market has the highest requirements for liquidity and corporate governance. The Standard section has lower requirements compared to the Prime market, while the Growth market is for smaller and emerging companies.

In March 2023, the TSE requested all companies listed on the Prime and Standard markets to implement strategic policies that would enhance corporate value by tackling some fundamental issues that have long been regarded as thorns by investors. The main issues plaguing Japanese corporations include low returns and a distorted view of cost of capital, low profitability and valuation, and inefficient balance sheets.

The TSE published a follow-up document in February 2024 to guide the country's corporations in addressing these key issues, which investors expect Japanese CEOs to tackle.¹

Implications for investors

These unique characteristics of the Japanese market present challenges, and a manager with experience and insights in the market has an edge. Managing country-specific allocations is difficult to implement for many investors.

An alternative way for them to access the market would be through an equity fund that has exposure to Japan.

For more detail, read the full paper.

¹ https://www.jpx.co.jp/english/news/1020/u5j7e50000001bqd-att/240201en.pdf

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