23rd October 2026
Back in 2019 I went on holiday with friends to Japan, visiting the tropical beach island of Okinawa, the bright lights and noise of Tokyo, deer strewn Nara, and temple lovers’ Kyoto. Thanks to decades of deflation, despite cramming in lots of activities, travel, and meals out, it didn’t break the bank.
Since my visit, the times have changed. Japan is no longer mired in a deflationary spiral and over the past 5-years inflation has crept back into the economy and bond yields have reacted moving meaningfully higher. Amazingly, the yield on the 30yr Japanese government bond has overtaken the yield on the 30yr Chinese government bond. This, combined with the corporate governance reforms that have been going on for well over a decade, has transformed the opportunity set for investors in Japan and means that despite strong returns in recent years there remain good opportunities for investors to exploit.
Corporate governance reforms
In 2013, Prime Minister Shinzo Abe formally made corporate governance reform a core pillar of economic revival in Japan with a focus on boosting return on equity and attracting global investors. Since then, a wave of policies have been implemented including The Ito Review (setting minimum ROE targets and urging unwinding of cross-shareholdings), Corporate Governance Code (forcing companies to have at least 2 independent directors on the board), Fair M&A Guidelines, and Tokyo Stock Exchange reforms (including a name and shame directive where companies trading below a price-to-book ratio of 1x have to disclose plans to improve capital efficiency and stock valuations). In 2026, the Corporate Governance Code has been revised to promote growth and long-term value creation with greater emphasis on capital allocation and board effectiveness.
Activists have entered the market in a meaningful way and have been leveraging the reform backdrop to their advantage to unlock some easy wins and returns. Within the UK investment trust arena, Nippon Active Value has been particularly successful in deploying this strategy, taking large stakes in smaller Japanese companies, and heavily engaging to unlock the value.
You don’t need to take an activist approach to benefit from these changes, however. The reforms mean that return on equity across the market is rising, free cash flow generation is now translating into rising dividend yields and share buybacks, where in the past it would have resulted in increasingly bloated balance sheets full of cash yielding next to nothing. CC Japan Income & Growth has been a meaningful beneficiary with strong returns over the past 5 years, and dividend growth compounding at close to 8% a year (in GBP terms) since it launched in 2013 when the reforms began.
Inflation changes the game
The shift in the inflation backdrop in Japan has significant investment implications. Decades of near zero rates has created zombie companies that are coming under pressure in the new environment and must be avoided – but it’s also important to look at where other companies may be exposed to zombie risks and deep dive on supply chains and customers.
During the long deflationary environment, keeping cash under the mattress made sense as all the things you wanted or needed to buy would be cheaper in the future. That strategy doesn’t work in an inflationary environment, so the nation of savers needs to consider putting that massive cash pile into financial assets to maintain its spending power in real terms. This shift in investment behaviour should increase flows into the stock market and would be good for banks and wealth managers who can earn commissions and fees from this demand.
There are signs of changing worker behaviour. In Japan it used to be very common for a worker to spend their entire career at a single company (salarymen), with wages and seniority directly linked to tenure at a company. Labour mobility has been rising as the pool of skilled workers diminishes with the aging population and younger workers facing a cost-of-living crisis (energy and food inflation has been acute) are keen to capture wage growth sooner. In time, stronger wages should start feeding through into changing consumption habits which should create new investment opportunities.
Eyes on the bond market
Gross debt-to-GDP in Japan is very high compared to the other G7 nations (US, UK, Italy, France, Canada, Germany) at over 200% and is a point of concern, especially against a backdrop of rising rates that may put pressure on government finances. There has been growing concern from market strategists about the risks of rising bond yields in Japan to the global economy.
Due to decades of low interest rates and a weak currency, domestic investors in Japan have sought greater returns and to protect their spending power by investing in overseas assets. Japan is the largest foreign holder of the US Treasury market, for example. Meanwhile, hedge funds and other large institutional investors have deployed a yen carry trade strategy (borrowing yen cheaply at near zero interest rates and converting it into foreign currency to buy higher yielding assets globally). In August 2024, the Nikkei 225 index fell over 12% in a single day, it’s worst one-day loss in history, and global markets were rocked by an unexpected rate rise by the Bank of Japan. This catalysed a sharp unwinding in the carry trade with the yen surging versus global currencies and forcing margin calls. With the 30-year yield now at all-time highs and recent interventions in the yen by the US government, there is potential for further unwinding of the carry trade.
A rising yen has obvious implications for the types of companies an investor might choose to invest in. While many companies have costs and liabilities in all parts of the world, avoiding exporters (autos the obvious example) and favouring domestic orientated businesses, such as most smaller companies, would make sense.
Market concentration
We have written about the extreme concentration in global equity markets around technology and AI, driven by index concentration to these themes in the US and EM/Asia – see here (Heavyweights crescendo from June). While Japan is a beneficiary of the AI build out with many global leading technology manufacturers and materials businesses, these companies do not make up huge percentages of Japanese equity indices – indeed many tend to be in the small and mid-cap space. Information Technology makes up less than 20% of the MSCI Japan index, compared with nearly 50% for the MSCI Asia ex Japan, so can bring sector diversification benefits to portfolios.
Overall, despite excellent returns from Japanese equities in recent years, the backdrop remains robust. Corporate governance reforms continue to translate into strong returns for shareholders, and while some of the lower hanging fruit has been picked and enjoyed, the structural changes to corporate Japan will continue to boost shareholder returns long into the future. Inflation and higher nominal growth are providing a further boost to earnings, and companies with pricing power are benefitting from the changed environment with margins expanding too. Portfolio construction benefits from having yen and low direct AI exposure are also useful at a time of record index concentration in a single theme.
Dan Cartridge – Fund Manager
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