By Mark Jason
Last year, Bank of Japan Governor Haruhiko Kuroda made a pledge when he came into office to "make an all-out effort" to improve the Japanese economy. Investors were quick to react positively to this declaration, despite the risk of failure that we saw.
Such "gung-ho" investors, who were the big winners in last year's rally, have since pulled back, and the risk that Prime Minister Shinzō Abe's economic plan may not work sufficiently is slowly being priced in.
In the past, we've stated that breaking free from two decades lost to stagnation is a difficult challenge for Japan, as we believe that achieving real economic growth requires changes that are very difficult and hard to come by. In fact, our team continues to believe this, as evidenced by the underweight in Japan (relative to benchmark index) across several of our funds. (Invesco International Growth Fund (AIIEX) = 6% vs. MSCI All Country World ex- US Growth Index = 14%; Invesco Global Growth Fund (AGGAX) = 4% vs. MSCI All Country World Index = 7%)
As we communicated in a blog post earlier this year, our team passed on Japanese companies in the fourth quarter of 2013 in favor of other companies in the Asia-Pacific region that more closely adhered to our EQV (earnings, quality and valuation) criteria.
However, now that Japan is cheaper than what it was at the beginning of the year, we're finding selective opportunities.
For example, in the first quarter, we added Japan Tobacco (OTCPK:JAPAF), the world's third-largest cigarette manufacturer, excluding China. (0.74% of Invesco International Growth Fund). Japan Tobacco is attractively valued considering it has the prospect of improving profitability, particularly in emerging markets, which account for about one-third of the company's sales. We also see improving shareholder returns through potential buybacks and dividend increases.
Despite our interest in Japan Tobacco, overall, we believe there are reasons to still be cautious about Japan:
- Japan has lower expected returns with similar valuations in comparison to the rest of the world: The return on equity for the MSCI Japan Index is less than 10% versus nearly 15% for the MSCI All Country World Index, while price-to-earnings ratios for those two indexes are roughly equivalent - at about 13x.
- EBITDA margin, which measures profitability, for the MSCI ACWI ex-U.S. Index is nearly 24% versus only 16% for the MSCI Japan Index.
Although Japan is a large and important equity market, we continue to remain underweight while pursuing select opportunities that adhere to our EQV criteria mentioned above.
Holdings are subject to change and are not buy/sell recommendations.
The MSCI Japan Index is an unmanaged index considered representative of stocks of Japan. The MSCI AC World Index is an index considered representative of stock markets of developed and emerging markets.
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