Risks and rewards of Japanese equities

Investors face systematic risk (also known as ‘market risk’ that is an un-diversifiable risk) and non-systematic risk (which is idiosyncratic risk unique to a specific business or sector and can be mitigated through portfolio diversification across a range of companies, sectors and industries).

Of course, investing in Japanese equities carries with it currency risk for investors whose reference currency is not the Japanese yen.

There are, additionally, risks relating to the politics, economics and geography of Japan that are unique to investing in Japanese equities.

The potential rewards, of course, stem from the possibility that these risks may combine with other risks – inherent in other asset classes and regions that may be present within a diversified portfolio – in a way to deliver a smoother, better risk-adjusted return profile.

The Japanese economy can still to some extent be seen as a global cyclical, given the makeup of its listed companies, Michael Stanes, investment director at Heartwood Investment Management, says. He says it can therefore be more volatile.

Also, he says Abenomics, whether real or not, is a factor in the performance of the equity market, unlike other markets.

The Japanese equity market has also historically been very sensitive to movements in the yen exchange rate, corporate Japan being seen as a beneficiary of a weak currency, though Mr Stanes says there is some evidence that this might be changing.

As for the rewards, while investing in Japan has become much more popular in the last year or two, Mr Stanes says it is still fair to say that Japan is probably still much under represented in global portfolios, and certainly in relation to the size of its economy.

Mr Stanes says there is therefore the potential for continued foreign investor flows into Japan should conditions continue to improve.

Japanese equity markets have performed strongly in recent years and Nick Peters, portfolio manager at Fidelity Solutions, says he believes they should continue to do so, with the economy benefiting from the weak yen and the continued quantitative easing programme of the Bank of Japan.

While this supportive environment remains in place, Mr Peters says there are concerns around the slowdown in China, which may have a negative impact on global economic activity and Japanese exports.

Although Japanese GDP was weak in the second quarter, Mr Peters says its gross national income (GNI) was strong and grew at 2 per cent.

He says this may indicate that Japanese business is doing well relatively overseas (as shown by positive earnings momentum) but that these earnings are not feeding through to domestic wage increases or additional Capex spending.

However, if companies start to spend more in the Japanese economy, Mr Peters says this could be positive for the country and its GDP figures.