Feature – Japan
selling the yen and buying dollars and voila, the depreciation of the yen,” he adds. But this system is increasingly coming under pressure, as the yen has fallen to a 24-year low against the dollar. Japan is now at a turning point, facing two fundamentally different out- comes. If the Bank of Japan continues its policy of easing, then this could push the yen even further downwards. But another scenario is that the nation could meet global inflationary pres- sures, which would force central bankers to steer away from the course they have followed during the past decade and intro- duce monetary tightening measures. All eyes are now on the Bank of Japan, whose policy measures could play a decisive role. Govinda Finn, Japan and developed Asia economist at Kobe University, argues that Haruhiko Kuroda, the outgoing governor of Japan’s central bank, is caught between a rock and a hard place. “The Bank of Japan is now paying the price for a loss of inde- pendence. There are two reasons why it cannot take independ- ent decisions. One is the issue about sustainability of Japanese debt. High debt-to-GDP levels mean that keeping interest rates low has become important. And the second is that the head- winds Japan has seen from a demographic perspective and its low growth environment are not going away,” he says, suggest- ing that the central bank is likely to keep a relatively accommo- dative stance for the time being.
Investment impact
The outcome of these decisions matters to UK institutional investors, for many of whom Japanese stocks are a core ele- ment of their developed market equity portfolio. For example, Japan accounts for around 8% of the MSCI World index, so many institutional investors will have had exposure to Japan baked in by default.
There are arguments in favour of being overweight Japan. By the end of last year, the Topix started to outperform other devel- oped market indices, a trend which was at least in part driven by investor expectations that the Bank of Japan would continue its loose monetary policy.
One example of a fund that has fared well with its exposure to Japanese stocks is GPIF, the ¥196.6trn (£1.2trn) investment behemoth, which manages the retirement savings of govern- ment employees, booked a ¥1.8trn (£14bn) gain on its Japanese equity holdings in the third quarter of 2021 alone. This upwards trend for Japanese stocks was at least in part driven by the expectation of further accommodative policy in Japan, GPIF president Masataka Miyazono explains. Japa- nese stocks account for almost a quarter of the pension funds’ asset allocation. But at the beginning of this year, the picture changed somewhat and Japanese stock markets also started to fall.
52 | portfolio institutional | September 2022 | issue 116 Currency effect
One factor that has always played in GPIF’s favour is the cheaper value of the yen. The rising cost of the dollar has bol- stered the investment performance of a fund that pays out ben- efits in yen. But for UK investors, the precise opposite holds true, as James McLellan, senior portfolio manager at Border to Coast says.
The £60bn local government pension scheme pool has about 10% of its £5bn developed market equity fund invested in Jap- anese stocks and McLellan is keen to stress this position is not influenced by short-term speculation on the Bank of Japan’s next steps. “We run a fixed allocation on the equity side which we rebal- ance on a quarterly basis and so we do not play allocation as a source of alpha or to express our views,” he adds. But as a fund that measures its performance in sterling, the sharp fall of the yen has affected the investment returns, he says. “The performance of Japanese stocks has been quite good though it t is a different story when you look at it in dollars or even in sterling. It has still done relatively well but it’s not done as well as the headline yen number would suggest,” he adds. Yet McLellan sees indications that the plunge of the yen may have reached its peak. “Previously when the yen has reached these levels against the Chinese yuan then it has marked a bit of a limit and it becomes more relevant to China because their competitive position is being threatened by the weakness of the yen,” he says.
The headwinds Japan has seen from a
demographic perspective and its low growth environment are not going away.
Govinda Finn, Kobe University
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