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My sister and I were eating Weet-Bix (as they’re called in Australia) with muesli on top in the kitchen. Dad walks in and plops the morning paper on the counter. “Well, bugger me. Japan’s stock market is now the biggest in the world.”
Four decades ago and I remember it clear as glass. As teens with no interest in share prices, even we felt the impact. All of us learned to speak Nihon-go (Japanese) at school. The streets over-ran with Japanese tourists clad in Burberry.
This explains a love affair that many of my generation share. I worked as a construction worker in Kanazawa for a year before university. My first serious job was managing Japanese equity portfolios.
As I have written previously, the latter was both psychologically and financially ruinous. While our colleagues popped corks in the dotcom boom, we in the Japan team spent year after year apologising to clients.
Five of us still meet up annually for counselling. So Thursday’s milestone of the Nikkei 225 index finally surpassing its 1989 peak in nominal terms — it’s still about a fifth lower after adjusting for inflation — touches a nerve.
I’m pleased that a few old Japan hands are finally experiencing a bull market. Maybe they can retire at last. Meanwhile, I’m jealous of the newbies who never suffered like we did and are partying in Roppongi as I write.
That I have been running a very large bet on Japan stocks helps. When this column began in November 2022 my portfolio had 11 per cent in them — worth a total of £48,000. I added an extra £9,000 when I sold my banking sector ETF last summer.
Today the exposure is £90,000 and accounts for a fifth of my portfolio. That’s a chunky bet considering that Japanese stocks only make up 6 per cent of the MSCI World index. Of a balanced fund, which includes bonds, a sensible allocation would be lower still.
So I hope you will forgive me for giving my Vanguard Japan ETF a quick going over. I know I promised to review my Asian fund in this column — but I’m worried all of a sudden. Should I trim Japan a bit? Bail completely? Do nothing?
For starters, I’ve forgotten what is even in this ETF. This matters because there is a big difference between the various Japanese indices. For example, few people appreciate how silly the Nikkei 225 index is.
Like the Dow Jones in the US, the Nikkei is an old-fashioned price-weighted benchmark. It is simply an average of all the share prices. So a small company with a high share price moves the index more than a megacap with a lower price (perhaps after multiple share splits).
Professional Japanese watchers never give the Nikkei a thought, concentrating instead on the Topix, a market capitalisation-weighted index of 2,115 companies trading on the Tokyo Stock Exchange. And boy, are they different.
For example, Fast Retailing is the biggest stock in the Nikkei with a 10 per cent weighting, while SoftBank is number 4. But in the Topix they are ranked 44th and 22nd respectively. Japan’s largest company — Toyota — is not in the Nikkei top 10.
Indeed, the more representative Topix index remains almost a tenth below its 1989 peak, and that’s in nominal terms. Forget the Nikkei headlines, therefore. It’s not time to bust out the sake cups just yet.
So what is in my ETF? Well, it is designed to track the FTSE Japan index and in fact holds exactly the same 511 stocks (many ETFs can produce low tracking errors with many fewer stocks than the underlying index).
And the goal of the FTSE Japan index is to “represent the performance of Japanese large and mid-cap stocks”. It does this by replicating the Topix index but lopping off the smallest three-quarters of companies by market capitalisation.
So basically the largest names in my ETF and the Topix are identical, with the weights the same too. What does this mean in practice? First, a large exposure to technology stocks. These are benefiting from the boom across the Pacific.
This is great because I have no US equities at all. The Topix is also heavily weighted towards industrials — think robots, semiconductors, sensors and the internet of things — as well as consumer plays and banks.
The latter two are boring, but should do nicely as Japan recovers from decades of moribund growth, not to mention years of deflation. The fourth biggest sector is healthcare. I have no problem with that either, given the average age is 49 and rising fast.
Experience tells me I could do better, however. The biggest names in my ETF are not the most dynamic businesses in Japan, nor the cheapest, with an overall price-to-earnings ratio of 15 times and a price to book of 1.4 times.
The Topix overall has 40 per cent of its constituents trading below one times book value. In other words, if you shut those companies down and sold their assets, you’d make money. But they are the smaller stocks and my ETF has relatively fewer of them.
Maybe I’ll look at some small-cap funds over the coming months. Overall, though, my investment thesis remains intact: Japan has attractive valuations and increasingly shareholder-friendly governance. More consolidation and M&A is likely. The country should also benefit if global relations with China worsen.
I do worry that a sudden reversal in the weak yen will hurt some of the biggest names in my ETF — namely exporters such as Sony and Toyota. That said, they are more diversified than they used to be, and any transactional pain will be offset by better sterling returns for me.
There’ll be no disturbing my Godzilla-sized weighting in Japan for now.
The author is a former portfolio manager. Email: stuart.kirk@ft.com; Twitter: @stuartkirk__
