The Great Wave off Kanagawa is a seminal piece of Japanese artwork. Created by Katsushika Hokusai in 1831, it depicts three ships struggling against the seas off the coast of Japan – and has been argued to be one of the most recognisable pieces of art ever made. In some ways it has also, until recently, been an apt metaphor for Japan’s equity markets; its returns have seemingly been fighting against the tides of global markets, held back by a weakening currency and the relative attractiveness of overseas equities.

The Great Wave’s significance also extends past its artistic merit as an example of increasing western influence on Japan – particularly its use of ‘Prussian blue’, a colour that was newly imported to Japan from Europe. Modern Japan is also witnessing its own markets undergo their own ‘westernisation’, thanks to the significant corporate governance reforms that have been implemented, with shareholder rights slowly reaching the levels expected in the West.

Furthermore, just like the storm depicted by Hokusai, all tides must turn eventually and the currents finally seem to be moving in favour of Japan. The possibility of an appreciating Yen and the inherent idiosyncrasy of Japanese equity returns may place it in a favourable position.

Why Japan now?

Japan has already attracted some noteworthy investor interest – Berkshire Hathaway has, in their most recent annual shareholder meeting, signalled its long-term commitment to the Japanese equity market with $24bn invested in the region. JPMorgan is also bullish on the outlook for Japan. In its global outlook for 2025, JPMorgan estimate a possible 10% upside to Japanese equities over 2025, more than they expect for any other major region.

Currency

The yen has long been the bane of overseas investors in Japan, as it has been on a near consistent downward trajectory relative to other major currencies for much of the last five years (as seen in Figure 1), for example, costing sterling-based investors c.30% via depreciation. In terms of purchasing power parity, the yen is trading close to fifty-year lows, which gives an indication of how cheap Japan’s currency has become. For comparison, sterling has been largely flat in PPP terms since 1995.

However, having already halted its decline at the start of 2025, Japan’s currency may be on the cusp of a material currency revaluation, thanks to Japan being behind the inflationary curve relative to other developed markets. The Bank of Japan may end up taking a more hawkish approach to monetary policy than other nations, having raised interest rates again at the end of 2024 and, while still only 0.5%, this is the highest level in 17 years.

Nonetheless, Japan still faces material inflationary pressures, which could bolster its currency through higher interest rate expectations. As seen in Figure 2, the post COVID period has marked the first time since 1992 that Japan’s CPI (specifically Japan CPI Nationwide Ex Fresh Food YoY, the Japanese Central Bank’s preferred inflation metric) has exceeded its 2% target for more than a year. Wage growth in Japan has accelerated significantly – up 5.3% year-on-year (the largest annual increase in the 21^st century) – adding more pressure on prices as well as the demand for the yen. Japanese wage growth has already led the more hawkish members of the Bank of Japan to call for two more rate hikes in 2025.

Japan has a strong domestic economy but is still a major exporter globally with its exports accounting for around 15-18% of GDP annually and so Trump’s recent ‘Liberation Day’ tariffs are bound to have some impact, but not as much as say in China (where exports are typically 20-25% of GDP) or South Korea (45-50%). However, it is likely too early to measure their net effects on Japan’s economy. The governor of Japan’s Central Bank notes that US tariffs are likely to exert downward pressure on both Japanese and global economic activity and that it is also “hard to say now how US tariffs will affect Japan’s price moves”.

Thankfully, Japan’s sectoral growth trends should continue to make progress despite the huge uncertainty around US trade policy – with one of the key developments being improvements in governance and shareholder alignment.

Governance

2024 marked the 12^th year of Japan’s corporate governance reform initiative. This is a government-and-regulator led policy designed to improve shareholder returns and address structural issues in Japan’s corporate governance practices that are holding back the potential of its equity markets. Last year was record year for this according to certain key metrics.

2024 saw the highest number of share buybacks in Japan’s history, with over ¥28tn being spent – double the level of the year prior. 2024 was also a record year for the number of M&A transactions, which reached its highest level since 1985. 2024 was also the first year that the total number of companies on the Tokyo Stock Exchange decreased, after 94 companies de-listed, a sign of the regulator’s drive to improve the quality of Japan’s listed equities (in part a reflection the government’s push for the removal of listed subsidiaries that are majority owned by a parent).

There are signs that 2025 will see these trends advance even further, with analysts predicting buybacks to reach ¥30trn in 2025. 2024 also saw a record number of activist investors enter the Japanese market – combined, activists are now holding ¥3trn in stakes spread across 120 companies – which could be another catalyst for further shareholder improvements in 2025.

There is also room for further pushes by Japan’s regulator for corporate reform. Japan’s average return on equity remains stuck around the 10% level – barely above the minimum 8% target recommended back in 2014. Despite clear progress in unlocking value in Japanese equities and strong earnings growth, too many Japanese companies still have a tendency to hoard their earnings and accumulate cash on their balance sheets.

Sector review

2024

Large cap

The standout performer over 2024 was the JPMorgan Japanese Trust (JFJ) – a growth-oriented strategy that seeks to capitalise on the opportunities within the ‘new Japan’. Examples include companies capitalising on the changing demographics within Japan, the attempts to modernise its – at times – archaic business practices, and the cutting-edge businesses that are driving Japan’s global dominance.

The most interesting takeaway from Figure 3 is how performance has not tracked investment style, and the second-best performing trust has been the Schroder Japan Trust (SJG), the most value-oriented strategy within its peer group. Interestingly, despite its bias to growth stocks, the standard deviation of JFJ’s NAV returns was not significantly higher than the benchmark’s.

Another factor that JFJ and SJG have in common is their high information ratio. This suggests that 2024 (and possibly 2025) is a year where successful stock selection outpaces style.

Small cap

With only three trusts left within the Japanese Smaller Companies peer group (following the merger of JPMorgan Japan Small Cap Growth and Income with JFJ in 2024, and Atlantis Japan Growth with the Nippon Active Value Fund in 2023 ), this peer group is increasingly focused on funds looking to benefit from the opportunities presented by Japanese corporate governance reform. AVI Japan Opportunity (AJOT) and Nippon Active Value Fund (NAVF) are both activist strategies seeking to agitate for improved corporate governance practices. Given the successful outcomes achieved by the wider market over 2024, it is no surprise to see that both AJOT and NAVF achieved double digit returns over the period.

For 2024, AJOT was the top performer, which may be due to its manager having more success recently in its activist campaigns (AJOT’s manager takes a longer-term approach to activism than NAVF, preferring an environment of co-operation as opposed to more forceful activism) as well as an increased allocation to higher quality companies who can still grow on the back of the superior business models, irrespective of their governance inefficiencies.

2025

While we are only three months into 2025, global equity markets have seen a significant shift in sentiment with Donald Trump’s tariffs upending the status quo for global trade. Equity markets across the board have responded negatively and Japan has been no exception, with its significant exporter base making certain segments of its market are particularly sensitive.

We think it is still far too early to make meaningful conclusions as to which of the strategies will be the least-worse-off in the end, although it does appear that some of the previous performance rankings have been upended, with Ballie Gifford Japan falling the least. But just like 2024, the NAV performance rankings of the large cap peer group over the first quarter don’t seem to be related to investment style. We think that 2025 could be another year of active management and stock selection driving returns.

The story is very different for the small cap peer group, however, as the trends of 2024 have carried over into 2025 – with AJOT once again leading the pack and demonstrating that the idiosyncratic returns generated from activism have outweighed market headwinds.

Much like the reforms being undertaken in Japan, activism and improving governance may become a boost for the shareholders in Japanese investment trusts – specifically for the two worst performing trusts in their peer groups: Fidelity Japan Trust (FJV) and Baillie Gifford Shin Nippon (BGS).

FJV has become the recent target of activism by AJOT, who have recently proposed merging FJV into AJOT, to offer investors a more attractive product – both in terms of potential returns and liquidity, while also offering a 25% cash exit for FJV’s shareholders. AJOT’s proposals benefit from having the support of FJV’s largest shareholder.

BGS’s board has been more proactive though, after reporting a second disappointing financial year. The board has now taken measures to shore up the resources available to its investment manager and is subtly adjusting its investment strategy to broaden its universe of companies. BGS also has a tender offer (conditional on its performance) and, if it can’t improve its performance, it may find itself another casualty of Japanese investor activism.