The question Nikko AM Chief Strategist Naoki Kamiyama has faced more than any other this year has been which asset class he would single out for investment in 2017. His response has consistently been: Japanese equities.
First, President Trump and the Republican Party are proposing tax cuts, while a global recovery in demand is boosting trade. Japan is expected to benefit not only from the price effects of yen depreciation but also from increased corporate earnings, as the economy expands production and sales volumes. The country is also looking more likely than ever to escape the deflationary spiral that has dogged it for so long, especially with the Bank of Japan (BoJ) maintaining its monetary policy targeting 2% inflation. This is driving inflation expectations, and corporate management strategies are likely to shift toward greater capital spending.
A second promising sign for Japanese equities is the fact that more and more firms are improving governance and emphasising efficiency and profit growth. As dividend payouts and share buy-backs increase, we expect margins to improve further.
Another important point is supply and demand. Japan’s negative interest rates have forced Japanese institutional investors –particularly banks – to shift away from Japanese government bonds (JGBs). Although the banking sector tends to invest for interest as well as dividends, it is increasingly shifting away from JGBs toward Japanese equities for their dividends, particularly through ETFs. Another factor is the ETF purchasing programme the BoJ launched in December 2010, with the aim of providing market liquidity and reducing risk premiums. Total purchases under the programme exceeded JPY 12 trillion as of March 2017, and the BoJ is continuing the programme with annual ETF purchases of JPY 6 trillion.
At the same time, significant government efforts have worked to shift retail Japanese investors’ focus from savings to investment, and we fully expect a portion of these assets to further drive demand for ETFs. Japanese retail investors represent an interesting demand dynamic as they hold an enormous JPY 1,700 trillion in financial assets. While the country’s ageing society is straining its pension system, the Financial Services Agency (FSA) has addressed this in part by setting up investment programmes such as the Nippon Individual Savings Account (NISA, launched in 2014) and the Individual-type Defined Contribution Plan (iDeCo, launched in 2017). The FSA is also looking into launching a new NISA system for cumulative savings.
There are three main ways for non-Japanese investors to efficiently invest in Japanese equities:
1. Directly holding Japanese equities
2. Utilising futures and other derivatives
3. Using ETFs (US ETFs, UCITS ETFs and Japanese ETFs)
Method 1 requires investors to take the time to select individual stocks and actively manage their holdings. The stock selection burden can be eased by holding passive portfolios, but this greatly increases the time needed to manage holdings due to the greater number of stocks held. As using listed futures in method 2 involves no counterparty risk and offers high liquidity, it has merits if the investor can handle the costs and quarterly rollovers involved, but the effort and costs involved are usually higher than those for Japanese ETFs. An example of this is the generally lower total expense ratio (TER) of Nikko Asset Management’s TOPIX ETF (Chart 1). In contrast, choosing method 3 requires consideration of the total costs of each ETF in light of their trading times, tax treatments and TERs.
Futures cost = Rolling cost (trade closing price on one day before SQ, 4 times a year) + opportunity loss of equity dividend
The trading time of an ETF is the time at which the trading hours of its underlying assets can be used to provide the greatest liquidity. In the case of ETFs investing in Japanese equities, this is Tokyo time (Table 1).
Source: Nikko Asset Management
Japanese ETFs also tend to have an advantage over ETFs domiciled in Ireland or the US when it comes to tax (Chart 2).
Tax treatment comparison of ETFs domiciled in Japan, Ireland, the US
Comparisons also show that Japan representative Japanese equity ETFs have lower costs (Chart 3).
A final important consideration is currency. Investing in Japanese ETFs generally requires changing US dollars or euros into Japanese yen which may have accompanying foreign exchange risk.
For cost-efficient exposure to Japanese equity markets, Japanese ETFs are a great vehicle to consider – Nikko Asset Management’s TOPIX ETF is one such example.
The views expressed in this article are those of the author and may differ from the published views of Commerzbank Corporate Clients Research Department, the communication has been prepared separately of such department. No representations, guarantees or warranties are made by Commerzbank with regard to the accuracy, completeness or suitability of the data.