PERSPECTIVES
Japanese equities: market turmoil masks an attractive domestic recovery
February 2016
Japanese equities offer investors exposure to a developed market that has a very different cycle to
Europe and the US. Despite recent sharp falls in the market, Japanese equities appear attractive in
the current environment, where the global economy is facing many concerns. Although the market
has been volatile since the start of the year, we believe that investors would do well to remain
focused on the numerous positive structural factors that are converging to make Japanese equities a
compelling strategic proposition.
In this paper Unigestion briefly reviews Japan’s current economic climate and delves into the set of
factors that we believe make Japanese equities attractive. We also recap how a risk-based
approach that targets asymmetric returns – more upside participation than downside – can help
achieve potential long-term outperformance in this equity market.
Japan’s positive economic climate
Gaël Combes
Fundamental Risk Analyst
Equities
Three years after the start of the unprecedented so-called “Abenomics” economic stimulus programme,
there are several elements, both domestic and external, that suggest Japanese equities are attractive:
The Japanese Yen is cheap: despite the recent rebound, the Yen is still close to its cheapest level
in 20 years. A cheap currency continues to provide support to Japanese equities as it helps make
companies more globally competitive. Also, while the Bank of Japan (BoJ) is not comfortable with
the recent Yen appreciation, we believe it would prefer to target an exchange rate around JPY120 to
the USD rather than an ever-depreciating currency.
Real effective exchange rates
Julien Malet
Investment Specialist
Equities
Summary
1. An attractive alternative to
other developed markets. In
a gloomy global
environment, Japan could
benefit from the
convergence of several
supporting elements.
Indexed to 100 as at 2010.
Sources: BIS, Macquarie Research (January 2016)
The TPP (Trans-Pacific Partnership): The TPP is a free-trade agreement negotiated over the last
7 years by 12 countries including Japan, the US, Canada, Mexico, Australia, New Zealand,
Singapore, Brunei, Malaysia, Vietnam, Chile and Peru. If approved by the US Congress, the TPP will
open most sectors to foreign competition (not allowed in Japan currently), which could lead to
significant opportunities for equity investors. Indeed, while exporting sectors in Japan have been
facing international competitive pressure for many years and have had to adapt (left chart, below), a
large productivity gap in the domestic economy (mainly the services economy) has been maintained
between Japan and the G10 countries.
Read more of our publications online: www.unigestion.com/publications/
2. Despite market volatility,
Japan is indeed undergoing
a domestic recovery. Our
Uni-Global – Equities Japan
fund is overweight domestic
sectors and set to
potentially benefit.
3. Managing risk effectively
across market cycles can
help achieve positive return
asymmetry and lead to
outperformance, especially
in Japan, where risks
remain.
Unigestion SA I 1/6
Source: Factset, Macquarie Research (October 2015)
As a consequence, the TPP is likely to force the least efficient companies to restructure or merge in
order to remain competitive compared to international players. This is likely to present opportunities
for equity investors.
The Abe government is committed to supporting both the economy and financial assets.
As an example of the assistance that the government has committed to providing to the Japanese
economy, the BoJ announced in December 2015 that it would start buying JPY 300 bn a year in ETFs
as part of its quantitative-qualitative-easing (QQE) programme. The size of the BoJ’s ETF purchases
should provide a significant additional source of support for the Japanese equity market. However,
regarding the effect of the negative interest rate recently announced, we admit we are sceptical
about whether this will have a meaningful impact on economic activity in the medium term.
Rising US interest rates have historically coincided with rallies in Japanese equities.
Investors in international equity markets may be concerned (though less so recently) about the effect
that rising US interest rates could potentially have on US and European equities. However, long-term
data, depicted in the chart below, show us that Japanese equities perform differently, and if history
is any guide, investors may take comfort in Japan even as US rates rise.
“Unlike the global index
valuation, there has been no
multiple expansion in Japan
for years: price increases
have been backed by
earnings improvements.”
Source: Bloomberg
At 14.5x 2016 earnings, valuation is attractive. Unlike the global index valuation, there has been
no multiple expansion in Japan for years: price increases have been backed by earnings
improvements.
Source: Unigestion, Bloomberg
Read more of our publications online: www.unigestion.com/publications/
Unigestion SA I 2/6
Furthermore, after a prolonged period of underperformance, the MSCI Japan Index started to
outperform the MSCI World Index last year in USD terms, as shown in the chart below. On a
relative-value basis the Japanese market is therefore showing signs of attractiveness when
compared to other developed markets.
Source: Unigestion, Bloomberg
Japanese equities: the recovery of the domestic economy
As promoted by the Abe cabinet for a number of years already, the investment story in Japan is the
recovery of the domestic economy. Indeed, in Abe’s programme, the 1st arrow (monetary stimulus, mostly
benefiting exporters through Yen depreciation) is now in the past, while the 2nd and 3rd arrows,
respectively based on fiscal stimulus and structural reforms, should benefit the domestic economy the
most. Domestically focused sectors, for example, infrastructure are likely to be the primary beneficiaries
of government support. As an example of this support, the government plans to cut corporate taxes by
2.5% (which represents an additional potential 3-4% of EPS for service sectors).
The Uni-Global – Equities Japan fund takes a risk-managed approach, where we seek to avoid taking
unrewarded risk. Our 360° risk approach seeks to create a risk-efficient portfolio, leading to potential
long-term outperformance. This risk-managed approach has led the fund to have overweight exposure to
domestic stocks, which are lower-risk stocks than exporters. The resulting exposure to the domestic
recovery story means the fund is aligned with the nature of the Japanese economy. The chart below
shows that the Uni-Global Equities Japan fund is significantly overweight the domestic versus the
exporter sector while the MSCI Japan Index is more neutral.
“…we expect portfolios with
a domestic consumption bias
to outperform …Uni-Global –
Equities Japan is well
positioned to take advantage
of the current environment.”
The split between domestic and exporter exposure is based on the breakdown of revenue of each
company between revenue from Japan and rest of the world. Thus, 70% of the revenues of companies
held in the Uni-Global Equities Japan fund come from Japan.
.
Source: Unigestion, Bloomberg as at 31 December 2015
Read more of our publications online: www.unigestion.com/publications/
Unigestion SA I 3/6
A low-risk approach allows investors to capture outperformance
Despite the attractive environment described in this note, many risks still remain in Japan (it has the
largest debt burden in the world, a huge budget deficit and a problematic ageing population) which, in our
view, justifies considering a risk-based approach to investing in this country. In March 2016 the UniGlobal – Equities Japan fund will celebrate its 10th birthday. The fund’s performance over the period,
shown below, demonstrates not only attractive performance, but also illustrates the success possible in
the Japanese equity market when taking an active approach to risk management. The fund’s track record
has benefited from its resultant asymmetrical profile, capturing more market upside than downside; this
has gradually built its outperformance over time.
Average monthly returns
Average performance participation
(monthly returns)
Please refer to the Important Information on performance at the end of this document. Past performance is not indicative of future
performance.
Sources: Unigestion, Bloomberg, Performance in JPY, gross of fees, as at 31.01.2016
“The fund will soon have a
10-year track record of
successful risk management.
The resultant strong upside
participation with less
downside has led to
attractive outperformance in
the long term.”
Please refer to the Important Information on performance at the end of this document. Past performance is not indicative of future
performance.
Sources: Unigestion, Bloomberg, Performance in JPY, gross of fees, as at 31.01.2016
Read more of our publications online: www.unigestion.com/publications/
Unigestion SA I 4/6
As of 29.01.2016
Uni-Global - Equities
Japan SA-JPY - gross
of fees
MSCI Japan TR Net
-4.70%
9.34%
20.35%
14.96%
5.20%
-7.64%
1.26%
17.04%
10.68%
0.01%
15.93%
16.95%
19.41%
21.84%
Return
YTD performance
1 year rolling
3 years p.a
5 year p.a.
Since inception (13.03.2006) p.a.
Risk Statistics (weekly basis)
Volatility 5 years
Volatility since inception
v.s. MSCI Japan TR Net (3 years rolling)
Tracking Error
Alpha
Beta
Maximum drawdown since Inception
7.91%
4.98%
0.82
-43.41%
-61.32%
Drawdown period (number of weeks)
16.04.07 / 27.10.08 (52)
26.02.07 / 12.03.09 (70)
Recovery period (number of weeks)
27.10.08 / 08.04.13 (152)
12.03.09 / 21.04.15 (209)
Bull participation
Bear participation
75.70%
56.61%
Please refer to the Important Information on performance at the end of this document. Past performance is not indicative of future
performance.
Sources: Unigestion, Bloomberg, Performance in JPY, gross of fees, as at 31.01.2016.
Conclusion
Japanese equities are still benefiting from a positive environment with both internal and external
supportive elements: strong backing by the Abe government, attractive valuation and the potential to
benefit from the TPP agreement. However, some risks remain: Japan still has the highest debt level in the
world at almost 250% of GDP, a huge budget deficit and workforce-related demographic concerns. While
Japanese equity indices are dominated by exporters, a risk-based strategy will favour domestic growth
and, as the recovery broadens out, it will benefit an economy more orientated to domestic consumption.
In summary, we expect portfolios with a domestic consumption bias to outperform those that favour
large-cap, export-orientated stocks. The Uni-Global – Equities Japan fund possesses these characteristics
and is well positioned to take advantage of the current environment:
Strong performance track record since inception on 13.03.2006*;
Low downside participation, which has made the portfolio resilient to short-term negative shocks;
Exposure to domestically focused stocks that allow positive participation in Abenomics.
*Please refer to the Important Information on performance at the end of this document. Past performance is not indicative of future
performance.
Read more of our publications online: www.unigestion.com/publications/
Unigestion SA I 5/6
Important Information
This document is addressed to professional investors, as described in the MiFID directive and has therefore not been adapted to retail clients. It is a promotional
statement of our investment philosophy and services. It constitutes neither investment advice nor an offer or solicitation to subscribe in the strategies or in the
investment vehicles it refers to. Some of the investment strategies described or alluded to herein may be construed as high risk and not readily realisable
investments, which may experience substantial and sudden losses including total loss of investment. These are not suitable for all types of investors. The views
expressed in this document do not purport to be a complete description of the securities, markets and developments referred to in it. To the extent that this
report contains statements about the future, such statements are forward-looking and subject to a number of risks and uncertainties, including, but not limited to,
the impact of competitive products, market acceptance risks and other risks. Data and graphical information herein are for information only. No separate
verification has been made as to the accuracy or completeness of these data which may have been derived from third party sources, such as fund managers,
administrators, custodians and other third party sources. As a result, no representation or warranty, express or implied, is or will be made by Unigestion as
regards the information contained herein and no responsibility or liability is or will be accepted. All information provided here is subject to change without notice.
It should only be considered current as of the date of publication without regard to the date on which you may access the information. Past performance is not a
guide to future performance. You should remember that the value of investments and the income from them may fall as well as rise and are not guaranteed.
Rates of exchange may cause the value of investments to go up or down. An investment with Unigestion, like all investments, contains risks, including total loss
for the investor. Uni-Global Equities Japan is a compartment of the Luxembourg Uni-Global SICAV Part I, UCITS IV compliant. This compartment is currently
authorised for distribution in Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Norway, Spain, UK, Sweden,
Switzerland and Singapore. In Italy, this compartment can be offered only to qualified investors within the meaning of art.100 D. Leg. 58/1998. Accordingly, its
shares may not be offered or distributed in any country where such offer or distribution would be prohibited by law. All investors must obtain and carefully read
the information memorandum which contains additional information needed to evaluate the potential investment and provides important disclosures regarding
risks, fees and expenses. Unless otherwise stated performance is shown gross of fees in JPY and does not include the commission and fees charged at the time
of subscribing for or redeeming shares.
Read more of our publications online: www.unigestion.com/publications/
Unigestion SA I 6/6