U.S. Investors Want More Exposure to Japan. Here’s What They Should Know Beforehand.

“At first, investing in Japan or predicting Japan is so difficult; it’s quite a unique market,” said Ryoji Musha.

Illustration by II

Illustration by II

Following Warren Buffett’s lead, U.S. institutions have begun to take a closer look at investing in Japan — but they have much to learn about the country before they bet on its success.

“At first, investing in Japan or predicting Japan is so difficult; it’s quite a unique market,” said Ryoji Musha, president of the investment research firm Musha Research. “And [it’s] not just the market — [it’s also] a very unique economy.”

Musha spoke Wednesday at the Nippon Club in New York, where prominent American pension funds, consultants, and family offices listened intently as some of Japan’s leading investors made the case for tapping the country’s markets at Soleil Global Advisors’ Japan Forum.

“Warren Buffett has made a lot of money in Japan in the last 18 months,” said David Baeckelandt, head of client relations at Sumitomo Mitsui Trust Asset Management Americas. “Other smart money is looking at Japan.”

According to a recent paper from GMO, Japan, along with emerging markets and Europe, offers “much better expected returns” than the U.S. equity market. As Institutional Investor previously reported, ValueAct Capital Management recently launched a new hedge fund strategy focused exclusively on Japan. The firm has been investing in the region for years.

The prevailing narrative stateside about investing in Japan today is that “this time is different.” Although an aging population and low share prices have plagued the nation’s economy for years, policy shifts and rising share prices may be signaling a change.

The country is enjoying increased tourism following the Covid-19 pandemic, more mature corporate governance regulations (in 2014, publicly traded companies were required to add non-executive members to their boards), and a shift in monetary policy.

In December, the Bank of Japan decided to expand how far the ten-year bond yield can move before the bank steps in. The change, from 25 basis points to 50 basis points, prompted investors to take a second look at the region.

Following that unexpected move, Haruyuki Toyama, an executive advisor at Sumitomo Mitsui Trust Bank who previously worked for both the Bank of Japan and the Federal Reserve Board, said, “many investors have suddenly become interested” in the country.

“The Japanese economy has gradually but steadily changed over the past twenty to thirty years,” he added. “It’s been measured, so outsiders may not have noticed.”

More recently, U.S. investors have had to contend with the geopolitical risk factors that could come with investing in China. Some have chosen to drop the country entirely from their portfolios, seeking instead to access similar economies in other Asian countries, including Japan.

Japan could also benefit from this trend in a less straightforward way. Changes in China, including geopolitical risk and the rising cost of outsourcing labor, have also prompted some local Japanese companies to consider shifting production onshore. It’s not an easy task: Japan’s aging population means that the labor supply is falling, and this dynamic is driving up wages.

“With those things in mind, it has been increasingly difficult to absorb rising costs,” Toyama said. Instead, companies may finally have to pass the increased cost of production on to consumers.

“That’s why I think the inflation rate would be more persistent than the Bank of Japan is thinking,” he added. In a country where deflation has been the dominant factor keeping consumers and companies from investing and making large purchases, rising inflation would likely be a boon to the Japanese market.

There are now numerous ways in which U.S. investors can take advantage of the region. For example, Yasunori Nakagami, chief executive officer at Misaki Capital, is tapping into activist investing in Japan. The firm runs a concentrated portfolio, in the belief that for some Japanese corporations, depressed share prices aren’t a result of asset turnover or leverage, but instead, can be attributed to margins that have been kept low by management.

“Warren Buffett says don’t invest in ABC — arrogant, bureaucratic, and complacent,” Nakagami said on Wednesday. “Misaki says invest in HOP.” This stands for “hungry for change and growth, openness to outside opinions, and public-company minded.”

Sumitomo’s asset management division, meanwhile, has focused heavily on microcap stocks in the region. More than 67 percent of all Japanese stocks are microcaps, and in the MSCI World Microcap Index, Japan makes up the largest percentage of stocks, at 29.48 percent.

“This is a very under-covered market,” Baeckelandt said. “Back in the ’80s, most of the stocks were well-covered in Japanese and English.”

At the Nippon Club on Wednesday, he suggested that investors should take an active approach in the region, given the idiosyncrasies of the market. “Japan is a market where if you don’t have people on the ground or you’re not tapped into people who understand, you’re not going to get critical information,” he added.