As Japan’s prime minister quits, time to rethink Japan exposure?

Tom Bailey considers what Shinzo Abe’s resignation means and runs through Japan ETF options.

On Friday (28 August), Japanese prime minister Shinzo Abe announced his resignation. The news was not totally unexpected, with Abe stepping down due to a chronic illness.

Nevertheless, the news was still somewhat of a shock. Abe took office for the second time in his career in 2012 and just days before his resignation had reached the landmark of becoming Japan’s longest-serving prime minister.

During his eight years in office, Abe had become synonymous with attempts to rejuvenate Japan’s ailing economy and restore the country’s status as an important global player. So synonymous in fact that Japan’s package of economic reforms was dubbed “Abenomics”. Reforms included a new corporate governance code, policies to boost tourism, increased regional trade integration, increased female participation in the workforce and corporate tax rate cuts.

This won the prime minister many fans abroad, particularly among those interested in investing in Japan. As any reader of the financial press will have noticed, during his eight years in office it was common to see investors or fund managers with exposure to Japanese equities rave about the potential of Japan owing to the reforms being pursued by the Abe government. The investment thesis for Japan could often simply be summarised as Abenomics.

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So, with Abe’s resignation, should investors now be rethinking their allocation to Japan?

Many of Japan’s reforms relied on Abe’s vision and authority. Whoever replaces him may not have the ambition to carry on his legacy. There are fears that Abe’s resignation could usher in a new period of political dysfunction. In the five years before Abe took office in 2012, Japan had five different prime ministers. A return to such dysfunction would make successful long-term reform much less likely.

Fortunately, many people are expecting relative continuity after Abe’s departure. His replacement will be decided at the Liberal Democratic Party’s (LDP) leadership contest later in September. The LDP is Japan’s ruling party, meaning that its new leader will also become prime minister. 

Pantheon Macroeconomics argues that the most likely successor is Abe’s chief cabinet secretary, Yoshihide Suga. That’s good news for investors, as Suga is seen as the “continuity candidate”, Pantheon Macroeconomics argues.

John Vail, chief global strategist at Nikko Asset Management, agrees with this assessment. He notes: “It is important to note that Suga is not just a safe pair of hands; rather, he has the same long-held vision as Abe and led his rise into his second stint as prime minister in 2012.”

Vail also notes that Suga, in his role as chief cabinet secretary, was responsible for helping push through many of Abe’s deeply resisted reforms and is considered to be a very effective policy leader within the party.

As a result, Suga is seen as key to Abe’s successful time in office. “Thus, it is highly likely that Suga will retain all of Abe’s major policies, including regarding corporate governance,” says Vail.

However, even if Suga is not successful, it is not likely that Abe’s agenda will be dropped. Joe Bauernfreund, portfolio manager of AVI Japan Opportunity Trust, argues that Abe will still have some control of who comes after him. He says: “Prime minister Abe is likely to retain significant influence over his successor, including future policy direction, so anticipate [that] the aggressive fiscal and monetary policy will likely remain in place for the foreseeable future.”

Meanwhile, researchers at Goldman Sachs argue that, whoever the successor is, the priority will be market stability, including defending recent stock-market gains. In a research note, Naohiko Baba of Goldman Sachs argues: “We think mitigating any economic and market disruptions potentially caused by Mr Abe’s sudden departure will be the most pressing issue at hand.

“A particular concern is that the departure of Mr Abe as the figurehead of Abenomics could cause a reversal of yen depreciation and stock gains, two pillars of Abenomics. Against this backdrop, any meaningful policy shift would be quite unlikely, in our view.”

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On top of this, key figures in Japan’s economic management will likely be staying put, adding to the sense of continuity. For example, finance minister Taro Aso is expected to stay in place, continuing to pursue policies to stop the yen appreciating too much. Second, as Pantheon Macroeconomics, notes: “The second five-year term of Bank of Japan governor Haruhiko Kuroda won't expire until 2023, mitigating uncertainty over monetary policy.”

Investing in Japan

In terms of investing in Japan, there are no shortage of options. Many UK private investors seem to prefer to gain Japan exposure through actively managed funds, particularly those looking at the smaller-cap end of the market. However, investors may also wish to consider ETF and index fund options. After all, like America, Japan is one of the world’s most efficient markets.

The most famous Japanese index is the Nikkei 225. As the name suggests, this tracks the 225 largest Japan-listed stocks. However, the index is not market-capitalisation weighted, instead using price weighting (like the Dow Jones in the US). The index is also not tracked by many ETF or index fund providers. The only one available on the interactive investor platform is the iShares Nikkei 225 ETF JPY Acc GBP (LSE:CNKY), with a relatively steep charge of 0.48%.

Lesser-known is the JPX-Nikkei 400 Index. This index is slightly different in that inclusion depends on several qualitative factors, most notably relating to the corporate governance policies of companies. The idea is that the index has a bias towards stocks that are more shareholder-friendly. Historically, Japan’s companies have not prioritised the interests of shareholders – an issue Abe tried to address in recent years. The index was created to attract foreign investors concerned about corporate governance in Japan. This index can be tracked using the Invesco JPX-Nikkei 400 ETF GBP (LSE:S400). With an ongoing charge of 0.12%, fees are relatively reasonable. Other options include the Xtrackers JPX-Nikkei 400 ETF 1D USD (LSE:XDNY), with an ongoing charge of 0.2%.

However, the most common way for investors to gain Japanese passive exposure is through an ETF or index fund tracking the MSCI Japan index. This index has just over 320 constituents and covers around 85% of the entire universe of listed equities in Japan. As you would expect, iShares offers several ETFs. The iShares Core MSCI Japan IMI ETF USD Acc GBP (LSE:SJPA) has a charge of just 0.15%. Other options include the index fund HSBC Japan Index C Acc, with an ongoing charge of just 0.12%, or HSBC MSCI Japan ETF GBP (LSE:HMJP) for 0.19%.

There is also the Vanguard FTSE Japan ETF USD Acc GBP (LSE:VJPB), which tracks the FTSE-Russell’s Japan index, for an ongoing charge of 0.15%.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.