AVI: We’re just at the beginning of governance reform in Japan

As bond investors grow uneasy and leadership hangs in the balance, corporate governance reform remains a dependable investment theme in Japan, says Asset Value Investors’ Nicola Takada Wood. 

AVI Japan Opportunity (AJOT) launched in 2018 after being incubated within the firm’s Global Trust. Managers identified what Takada Wood describes as a ‘once in a generation opportunity to participate in the rerating of the world’s third largest economy’, as former Prime Minister Abe planted the seeds for major governance reform. 

The £328m trust led by Joe Bauernfreund specialises in small-cap equities and takes an activist approach, encouraging companies to reallocate large amounts of cash sitting idle on their balance sheets. 

Change has motored along in recent years, with 2025 marking Japan’s third consecutive year of record shareholder returns through dividends and buybacks, alongside historic highs in takeover and M&A activity.

‘The market is really starting to streamline and less efficient companies that probably shouldn’t be listed are being absorbed or taken over, so you’re getting a much healthier market over time,’ Takada Wood said. ‘Particularly foreign investors have started to sit up and take notice as they’re seeing these metrics come through’.

More recently, markets have reacted positively to Thatcher-loving Prime Minister Sanae Takaichi, with the Nikkei climbing 10% since she won power, though a snap election looms later this week. 

The trust’s own benchmark, the MSCI Japan Small Cap, rose 19.8% last year, with shares in AJOT not far behind at 15.3%. Over five years, shares in the trust are up 66.3% compared to a 33% gain by the index. 

Bond sell-off

That optimism has been tempered by recent volatility in Japan’s bond market. Last month saw a dramatic sell-off in long-term bonds after proposals to suspend Japan’s 8% consumption tax on food unsettled investors funding the country’s massive government debt.

Talking to Citywire, Takada Wood explained these concerns were heightened by the scale of Takaichi’s broader spending commitments, including plans for a $135bn fiscal stimulus package.

‘People are concerned about potential over-spending in Japan, that it’s going to destabilise markets. They’re worried that those two factors are not going to be in balance.’

She also pointed to a lack of clarity around interest rates, with the Prime Minister backing easing monetary policy while the Bank of Japan has publicly committed to beginning a gradual tightening cycle after decades of near-zero rates.

‘There’s a lot of very interesting things going on in Japan, but the question mark that’s being reflected right now in the long-term bond market, is uncertainty.’

‘If Takaichi wins the snap election, what qualities is she actually going to put in place? How is that going to work for the Bank of Japan? What is the outlook for the fiscal situation for the next year or two?

‘As all those things become clearer, we will hopefully see some stability return, but at the moment, that market is telling you they’re not sure.’

Small-cap opportunity 

For the seven years since the trust’s launch, gains in Japan have been dominated by large cap exporters. International companies such as Toyota, Sony and Hitachi, have benefitted from a weak yen and familiarity among overseas investors. 

However, as governance reform continues to accelerate, Takada Wood says the opportunity is ‘trickling down’ to smaller companies.

‘That’s where you’re going to find the hidden value. The opportunities there also tend to be much cheaper and better capitalised,’ she reasoned, noting nearly 100 of these companies have about 30% of their market cap in cash. 

‘I think we’re actually nearing the beginning rather than the end of corporate governance reform in Japan,’ Takada Wood added. 

‘There are still 4,000 companies or so listed in Japan, that’s twice as many as the S&P – that doesn’t sound like a particularly efficient market. The Tokyo Stock Exchange has been very clear in that they think so too.’

‘I think what you’re going to see is a continuation of corporate activity. A continuation of mergers of takeovers, of management buyouts to make the entire market of a higher quality over time,’ she said. 

In November, AJOT completed a merger with Fidelity Japan, gaining approximately £184m in assets. As of yesterday, it trades on a tight discount of 2.6%.