On February 15, 2021, the Nikkei 225 index hit the 30,000 mark for the first time in three decades. The rebound is not a Japanese exclusivity, but it is fair to say that the improvement in transparency facilitated foreign investors’ come-back.
The language barrier used to play a significant role in foreign investors’ lack of interest in Japanese equities. According to a report published by the Tokyo Stock Exchange as of the end of 2020, 72.4% of companies listed on the First Section publish some sort of investor documents in English, an impressive rise from 55.6% in 2019… and a lot less a few years ago.
The Japanese accounting standard was said to be another repellent for foreign investors. Since the International Financial Reporting Standards (IFRS) was first implemented in FY3/2010, 234 companies representing 42% of the TSE’s total market value made the choice to use it. This is quite an accomplishment given the double reporting requirements, since Japan’s tax authorities require a Japanese reporting standard.
Cross-shareholding practices were also said to skew Japanese stocks’ valuations. Japanese banks and their corporate customers traditionally interlocked share ownership in order to secure the relationship and protect themselves from takeovers. Excluding insurance companies, cross-holdings fell from around 35% in 1990 to about 9% in FY3/19. Admittedly, the unwinding came more from market reasons than corporate governance, but it pushed companies to buy back shares to offset the resulting supply.
Japan also introduced new guidelines to prevent conflicts of interest between publicly traded companies and their listed subsidiaries. A significant portion of the board of listed units must consist of outside directors independent from the parent. The government is also considering requiring parent companies to explain their reasoning behind listing subsidiaries. The number of such listed units fell from its peak at 417 in 2007 to 259 last year.
Finally, Japan continues to raise its standards to an international level. A TSE reorganization is planned for 2022 where the current five sections will be down to three: Prime, Standard and Growth. With stricter rules on cross-shareholdings and corporate governance among others, the new Prime section will exclude many of the low-quality and low-liquidity companies currently listed on the First Section.
In this context, overseas investors stealthily rose from only 4% of the Japanese market in 1989 to around 30% lately. In the meantime, the Topix Index outperformed the Eurostoxx 50 index by 100% over the last 10 years. Although past performance is not an indication of future performance, it sounds like excuses for not holding Japanese equities are no longer shared as widely as they used to.
KH – April 12, 2021