Japan rising
David Prosser on whether the world’s fourth largest economy holds promise for UK investors.
Japan is the world’s fourth largest economy, and the size of its stock market is only eclipsed by that of the US. So why do so few investors in the UK have any meaningful exposure to the country? Funds investing in Japan account for less than 3% of all funds available to UK investors by assets under management.
The answer lies in the extended era of lacklustre returns delivered by Japanese equities over the decades following the stock market’s peak in 1989, a period characterised by deflation and industrial decline in the country. The fact that the Japanese market did not break back through its 1989 record high until February 2024 skewed the perceptions of a generation of investors. For a long time, Japan was effectively written off.
More recently, however, Japan has been transformed. Corporate governance problems that held Japanese companies back – encouraging them to hold on to earnings, rather than to reinvest or distribute money to shareholders – have been addressed through a series of reforms. Companies’ longstanding practice of holding large shareholdings in one another, effectively maintaining the status quo, have come under attack and such stakes have been unwound.
Japanese companies’ average profit margins are up 40% over the last year and now stand at their highest levels since records began; their share prices have soared accordingly – Japan was the world’s best performing major stock market during the first half of the year.
David Prosser
Combined with drivers such as stronger economic performance in Japan, the result has been a stock market boom. Japanese companies’ average profit margins are up 40% over the last year and now stand at their highest levels since records began; their share prices have soared accordingly – Japan was the world’s best performing major stock market during the first half of the year.
Does that mean Japanese equities are now over-valued? The short answer is no, at least by international comparisons. At the end of the first half, the average price to earnings ratio of companies in the MSCI Japan Index was around 21 times: the equivalent figure in the US was 28 times. And the Japanese stock market has cooled a little over the month or so since then.
None of which is to suggest investors should suddenly bet the house on Japan. But if you currently have little or no exposure to such an important global market, now might be a good time to consider remedying that.
In which case, investment trusts have much to offer. A number of closed-ended Japan funds and Japanese smaller companies funds have long track records; they’re run by specialist managers, often based in Japan itself, and their shares are listed on the London Stock Exchange, providing low-cost access to Japan through online investment platforms.
Importantly, investment trusts also offer an advantage over their open-ended peers when it comes to investing in a market such as Japan. While some of the country’s largest companies – think leading global technology companies and advanced manufacturers – offer exciting potential, Japan is also home to many small and medium-sized companies that fly under the radar. However, trading in these potential hidden gems can be illiquid, making it difficult for open-ended funds to buy them; by contrast, the structure of an investment trust means managers are less troubled by short-term liquidity issues.
Investment trust fans will also see a phenomenon in Japan that resonates. In recent years, UK investment trust directors have presided over unprecedented levels of share buybacks in an effort to improve shareholder value. Japanese companies have done something similar: share buybacks in the country increased by 250% to 17.8 trillion yen in 2025, up from 5.1 trillion yen in 2020.
These buybacks are likely to continue, adding to the potential for outsized returns from Japanese equities. There can be no guarantees – some analysts worry about issues such as Japan’s high level of public debt and its exposure to soaring global energy prices – but the country’s stock market has already seen quite the turnaround in recent years.
Interested in investing in Japan? Don’t miss hearing from four Japan fund managers at the Investment Company Showcase on 9 October.
