Japan equity index insights

Keep it brief

  • We are neutral on Japanese equities
  • We focus on yen correlation as a key risk differentiator between MSCI Japan IMI and MSCI Japan
  • We look at the benefits of a broad diversified index and think MSCI Japan IMI should form a core part of Japan equity allocation

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. You may not get back the amount originally invested.

Outlook for Japan

Inflows into Japanese equity funds have totalled $58.5B year-to-date, compared to $41.6B in 2017 (BlackRock Investment Institute, with data from EPFR, as at 31 October 2018). This year’s net inflows have been driven by domestic buying, with $62.3B added into Japan domiciled funds. Bank of Japan (BoJ) purchases ($47.1B, as at November 2018) have accounted for three quarters of this domestic buying. Foreign investor buying has lacked momentum this year.

See more ETP flows commentaries >

We maintain a neutral view on Japanese equities. The BlackRock Macro GPS indicates stable growth, with inflation trending higher but remaining below the BoJ target. We see a weaker yen, solid earnings and cheap valuations as supportive, but await a clear catalyst to propel sustained outperformance. Other positives include shareholder-friendly corporate behaviour, central bank stock buying and political stability. Japan’s economy appears to be more insulated from trade tensions than other regions.

Read our latest views on Japan >

Selecting an index

Selecting the right index to access Japanese equities is paramount, as the relationship with the yen – which may rally as a safe haven during periods of heightened uncertainty – is key. Given the MSCI Japan IMI index’s favourable relationship with the yen, historical risk adjusted performance, sector mix and valuation metrics, we believe this index offers a compelling way to gain exposure to Japanese equities.

Japanese equities for your core

When comparing the main Japanese indices – MSCI Japan and MSCI Japan IMI – there are several factors to consider.

Cumulative 5-year index performance

Source: Bloomberg & Aladdin, as at 28 September 2018.

Index performance (%) 2014 2015 2016 2017 2018
MSCI Japan 7.6 8.1 -2.6 17.6 -7.7
MSCI Japan IMI 8.2 9.1 -1.7 18.8 -8.2

The figures shown relate to past performance. Past performance is not a reliable indicator of current or future performance.

Source: Bloomberg, as at 7 November 2018. All performance analysis is at the index level. Index performance returns do not reflect any management fees, transaction costs or expenses. Indices are unmanaged and one cannot invest directly in an index.

1. International exposure and FX impact

At various risk-off points in 2018, selloffs in global equities triggered safe haven rallies in the yen, creating headwinds for export-focused Japanese firms.

The MSCI Japan IMI index derives a smaller proportion of revenue from overseas, due to its broader, more diversified range of constituents and exposure to domestically-focused small cap firms, which are not included in MSCI Japan.

Revenue exposures by country

Source: Bloomberg & Aladdin, as at 28 September 2018.

Our analysis shows that the yen tends to have a positive contribution to risk, indicating that during times of yen appreciation, the IMI index could outperform the MSCI Japan index. Furthermore, any deterioration in trade relationships would likely have a greater impact on the more internationally-exposed, less diversified MSCI Japan index.

2. Sector breakdown

The MSCI Japan IMI index broadly mirrors the MSCI Japan in terms of sector exposures, despite including exposure to an additional 958 stocks.

 

Benchmark Sector Breakdown

Source: Bloomberg & Aladdin, as at 28 September 2018.

3. Performance

The MSCI Japan IMI index maintains a low tracking error against MSCI Japan. It has also outperformed, at lower volatility, as reflected in the higher Sharpe ratio.

Rolling 1Y Sharp Ratio

Source: Bloomberg & Aladdin, as at 28 September 2018.

4. Valuations

The MSCI Japan IMI and MSCI Japan indices have comparable valuations (c.12.9x 12 month forward P/E for the former and c.12.5x 12 month forward P/E for the latter) (Bloomberg, as at 7 November 2018). The MSCI Japan IMI index has a lower average debt to equity ratio, which could be beneficial in a global tightening cycle. In addition to this favourable leverage ratio, the MSCI Japan IMI index’s higher average EPS growth ratio indicates stronger earnings potential in the broader index

Japan IMI as a core exposure

  • The MSCI Japan IMI index tends to be less affected by yen appreciation, as its broader, more diversified range of constituents derives a smaller proportion of revenue from overseas
  • The MSCI Japan IMI index has a lower average debt-to-equity ratio than the MSCI Japan index, which could be beneficial in a global tightening cycle
  • The MSCI Japan IMI index maintains a low tracking error against MSCI Japan, despite including exposure to an additional 958 stocks (1,280 constituents in MSCI Japan IMI compared to 322 in MSCI Japan)

Japanese equities for your core

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any financial instrument or product or to adopt any investment strategy.

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