Q. How are Japanese stocks looking now?

It’s been a tough year for all global markets, and Japan is no exception. The Topix has fallen more than 5% in yen terms, and 25% in US dollar terms, so far this year to September. A weak yen has played a role, with Japan an anomaly in its commitment to ultra-loose monetary policy, given low core inflation of just under 3%, and the fragile Covid recovery. That said, inflation expectations have risen sharply and are at their highest level since 2008, given that the weak yen has raised prices of imported goods.

Q. What has stood out for you in such a market?

With the macroeconomic backdrop, the market has favoured beneficiaries of inflation, such as interest-rate-sensitive stocks and those tied to commodities. In particular, financial and trading companies have done particularly well. Also, companies that benefit from the weaker yen have done better, although gains can be eroded by higher input costs, also due to the weaker currency. For various reasons, these groups of stocks tend to trade at lower valuations, typically termed as “value” stocks.

In contrast, better quality companies, and companies that are growing, have been out of favour, leading to declines in their share prices. This rotation in the market, from quality and growth to value stocks, is a reverse of what happened in the markets in 2020. In fact, Japan’s rotation this year has been the most extreme among major markets across the world.

Q. How are you reading the market movements?

As active stock pickers, we are constantly asking ourselves whether the environment has fundamentally changed the companies we invest in, and how we want to be positioned. And we return to the same conclusion again and again: there will be periods of headwinds for any investing style, but that is also when we will see opportunities. We invest for the long term, and there will come a time when the market starts re-evaluating better quality companies and rewarding them for their consistency.

Q. Where are you seeing opportunities today?

We have been looking at good companies that have been sold off, despite sound fundamentals, or where companies may have had a short-term issue. We recently invested in a healthcare company where the share price weakened due to slower sales in China, which we believe was an aberration. Another was an IT services company that should benefit from the increasing digitalisation of businesses, but where the stock price has fallen to more attractive levels.

Q. What should we expect in the coming months?

Signs of slowing growth are becoming more visible. Discretionary consumer spending is weakening, for instance. Concerns are also rising over the higher inventory levels across the board. But we expect spending to remain firm in areas like health care, the digitalisation of corporates and segments that are tackling rising energy costs. With this backdrop, we are selectively working on opportunities, and resizing positions, to ensure that our holdings remain resilient.

Q. What would you say to a potential investor?

Japan is one of the largest single-country markets, offering diverse exposure to companies ranging from global leaders in innovation to niche firms that are unique and indispensable. It is also the world’s third largest economy after the US and China.

While the opportunity is huge, investing in Japan also has its own challenges. Weak coverage and governance risks require effective due diligence and an active approach to contain risks and realise value. This favours active managers with fundamental research expertise.

Governance has been improving and we see this persisting for years to come. Cross-shareholdings are gradually declining. The voice of minority shareholders is increasingly being heard. We take a constructive approach in engaging corporates – often, with much success.

Q. What sets abrdn apart when it comes to investing in Japan?

We are well resourced across Asia, including an on-the-ground presence in Japan. The local team invests in well-run businesses, drawing on depth of coverage and corporate engagement. This is supported by a global research footprint and world-class ESG capabilities.

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