Is it time to invest in Japan? – 3 fund ideas

Like the name suggests, the Nikkei 225 is made up of 225 companies and is Japan’s most well-known stock market.

While US market highs might have been grabbing investors’ attention, Japan’s stock market has been on a record-setting rally, passing its December 1989 peak.

So, is now the time to invest in Japan?

This article isn’t personal advice. All investments, and any income from them, can fall as well as rise in value, so you could get back less than you invest. Past performance isn’t a guide to the future. If you're not sure if an investment is right for you, ask for financial advice.

So while optimism towards Japan has improved, the question is – can it continue?

What could this mean for investors?

Projections for 2024 and 2025 earnings have fallen across the world, but Japan is an exception. And it seems there’s room for growth, as profits are still below their pre-pandemic level.

Japanese shares also look good value despite recent stock market growth. They currently trade on a price-to-earnings (PE) ratio of 15x – a measure of how much a company’s shares are worth compared with its earnings potential. This compares with a PE greater than 50x during the stock market bubble in the late 1980s.

The economic conditions were different then – it was an extreme period of share price growth. But overall, Japanese valuations currently compare favourably with history and versus markets like the US.

Another positive is that Japan is no longer battling decades of deflation. This made it difficult for companies to plan and invest for the future, but in an environment of moderate inflation, companies are more likely to accept corporate governance reforms.

A change in habits by domestic Japanese investors could also help returns. Japan’s NISA – similar to a Stocks and Shares ISA – launched in 2014.

Designed to encourage Japanese savers to invest more, the amount that individuals can invest each year has increased significantly, doubling from 1.2m yen to 2.4m yen in the general NISA. This is around £6,350 to £12,700.

The tax benefits used to have a time limit, but this has been lifted, which could see people invest more and for longer.

Corporate governance reforms have drawn interest from overseas investors and, while China is facing some economic headwinds, they’re looking to other Asia Pacific markets like Japan for growth potential.

It’s important not to overlook the risks though.

Japan has faced many false dawns in the past, so there are no guarantees. The most likely risks that could stunt market growth include a slowdown in global growth, particularly in the US (relatively stable growth in the US has kept demand up for Japanese exports).

Any significant strengthening of the yen could also take the steam out of earnings, though this could see domestic companies do relatively better.

Subdued consumer spending could also be a headwind, but the shunto – Japan’s annual wage negotiations – could keep spending, and therefore inflation, buoyant.

How to invest in Japan – 3 fund ideas

One easy way to get exposure to Japanese shares is through a professionally managed fund made up of lots of different companies. This could be through a fund that invests globally, or one dedicated to Japan. Here we focus on three Japan-focused funds.

Investing in funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a long-term diversified portfolio.

For more details on each fund and its risks, please see the links to their factsheets and key investor information below.

Man GLG Japan CoreAlpha focuses on larger Japanese companies, some of which carry out business overseas. The managers use a contrarian approach often known as 'value investing'. Their discipline in buying out-of-favour companies and gradually selling them as they recover sets them apart.

They tend to invest in a relatively small number of companies, meaning each one can make a significant contribution, but it increases risk.

We think this fund could work well in a global equity portfolio designed to provide long-term growth. Its focus on large companies means it could sit well alongside a Japanese equity fund focused on medium-sized or smaller companies.

FSSA Japan Focus similarly invests in larger companies, but also invests in some medium-sized and more domestically-focused Japanese businesses.

The managers look for high-quality companies that are dominant in their industries. The team tends to invest in relatively few companies, meaning each one can contribute significantly to returns. Though this is a higher-risk approach.

The fund could help diversify a global investment portfolio. Its focus on high-quality companies with the potential for above-average earnings growth means it could work well alongside other value-focused funds.

iShares Japan Equity Index provides low-cost exposure to large and medium-sized companies in Japan. It aims to track its benchmark, the FTSE Japan, by investing in every company in the index. Around 5% of the fund invests in smaller companies.

Smaller companies have greater growth potential but can experience more extreme price movements. This can benefit the fund in the long term, but adds risk.

An index tracker fund is one of the simplest ways to invest. This fund could be a great, low-cost starting point to invest in Japan in a portfolio aiming for long-term growth.