Japan’s investment case is no longer about macro recovery — it is being driven by corporate transformation. Changing macro conditions, reform momentum, and the Bank of Japan’s changing policies are reshaping the outlook after decades of stagnation, while companies face pressure to improve governance, use capital more efficiently and boost shareholder returns. These themes were at the heart of Funds Europe’s Japan-focused roundtable held in London on March 26.
Participants included Nicolo Bragazza, associate portfolio manager at Morningstar Wealth; Preksha Shah, investment specialist at St. James’s Place; Simon Woodacre, fund research analyst at Quilter Cheviot; Marcus Weyerer, director of ETF investment strategy, Emea at Franklin Templeton; Francis Chua, multi-asset fund manager at Legal & General Investment Management; John Paul Temperley, portfolio manager on the Japanese equity team at BNP Paribas Asset Management and Naoya Oshikubo, chief market economist at Mitsubishi UFJ Trust and Banking Co. The roundtable was moderated by Funds Europe’s editor, Jonathan Boyd.
“Out of deflation, into inflation”
Naoya Oshikubo described an economy recovering from the pandemic shock, with a shift in its underlying drivers. “For the past two years,” he said, growth has been “especially driven by personal consumption and domestic capital investment,” rather than exports, which remain slow. Now, the engine is increasingly domestic.
Real GDP turned positive in Q4 2025, with the recovery expected to continue as rising real wages support consumption and companies sustain strong capital investment, particularly in software, said Oshikubo.
Wage growth has re-emerged after decades of deflation, driven by labour shortages and forcing companies to raise pay—a structural shift marking Japan’s move into an inflation era, said Oshikubo. Higher wages are supporting consumption and growth, while labour constraints are also pushing investment in automation and IT, making inflation primarily driven by domestic structural change. This shift is also forcing companies to reassess their cost structures and capital allocation, reinforcing the broader corporate transformation narrative.
Yet, as Preksha Shah pointed out, wage growth has been strong among large corporates, particularly through the Shunto wage negotiations (Japan’s annual spring wage talks). However, small and medium-sized enterprises—representing the bulk of Japan’s labour force—face tighter margins. “How much room do they actually have to increase wages?” she said. “All these factors take time.”
Shah also highlighted cultural factors at play. Japanese households tend to be more savings-oriented than their Western counterparts, meaning higher wages do not automatically translate into higher consumption. “We look at the macroeconomic situation positively, but allocators need to be patient,” said Shah.
Even so, the direction is clear. As Francis Chua said, Japan “feels like in a different phase,” highlighting a shift from its historically under-allocated position in global multi-asset portfolios.
Historically, exposure to Japan has been treated more tactically—“a pocket opportunity” where investors would enter and exit opportunistically. However, Chua questioned how far that still holds today, adding that there is now more confidence that Japan could warrant a higher structural allocation going forward.
That said, he cautioned that many of the positives may already be reflected, making execution and efficiency more important. “Currency dynamics remain a key driver of returns for international investors,” said Chua.
“Previously a valuation story, Japan is now a fundamental story due to corporate governance reforms. While macro is important, investors must balance it with fundamentals and valuation.”
-Nicolo Bragazza
Chips, AI and a strategic reset
John Paul Temperley compared today’s Japan with the market he began analysing 30 years ago, and said the country has “gone full circle”.
In the late 1980s and early 1990s, Japan was characterised by excess—too much leverage, overcapacity and surplus labour. Today, there is less leverage, tighter labour markets, and in some sectors, insufficient capacity.
The turning point, according to Temperley, began in the late 1990s with the repair of the banking system and corporate balance sheets, before accelerating with Abenomics (Japan’s post-2012 economic strategy under Prime Minister Shinzo Abe, built on three pillars: easy money, government spending and structural reforms to boost growth and end deflation) and corporate reform. What investors are seeing now is the result of that long process.
“It’s like turning an oil tanker,” Temperley said. “But we’re now in the middle of the first act of this long opera.”
That shift is feeding into capital allocation decisions. “Japanese companies are redeploying excess cash into growth areas, supported by a recovery in inflation expectations, which is influencing capital allocation decisions,” said Temperley. This redeployment of capital highlights a broader shift towards more disciplined and growth-oriented balance sheet management.
Government policy is reinforcing the shift under Prime Minister Sanae Takaichi, whose approval ratings are in the high 70s, with fiscal measures supporting households through energy subsidies, tax relief and targeted support, including a proposed temporary zero consumption tax on food. At the same time, the agenda prioritises investment in strategic sectors such as AI, semiconductors, nuclear, quantum technologies and next-generation batteries—backed by tax incentives, a more proactive industrial policy, and measures to strengthen cybersecurity, disaster resilience and foreign investment screening.
Together, these policies are accelerating capital deployment into strategic sectors, further embedding the shift in corporate behaviour.
Oshikubo’s broader market view also pointed to a style implication. Under Takaichi, long-term interest rates are expected to rise gradually as the Bank of Japan continues quantitative tightening. While some growth stocks, especially AI-related names, are attracting buying interest, MUFJ data shows value stocks are expected to continue outperforming against the backdrop of a gradual rise in long-term rates.
While the US, Taiwan and Korea dominate semiconductor production, Oshikubo said that Japanese companies remain strong in areas such as semiconductor materials and manufacturing equipment. In some parts of the supply chain, Japan “is still in the top position.” Oshikubo also pointed to the impact of US–China tensions, suggesting that Japan could benefit given its economic ties with both countries.
Unlike the US, where AI exposure is concentrated in software and platforms, Japan’s exposure is more industrial and hardware-driven. “The country benefits from the build-out phase of AI—data centres, automation, robotics and infrastructure—rather than purely from end-user applications,” Temperley pointed out. As a result, Japan’s equity market offers a differentiated way to access the AI theme, one that is less reliant on a small number of dominant technology firms.
“Conversations with major banks suggest a terminal rate above 2%, which could lead to a significantly stronger yen. This creates a potential “pain trade”, with markets too comfortable assuming a range-bound yen, while the risk may be skewed towards strength if rates rise more than expected.”- John Paul Temperley
From valuation to fundamentals
For many investors, the important shift is not macroeconomic but corporate. Japan has long been viewed as a valuation trade—cheap relative to other markets but lacking a compelling profitability story. That perception is changing.
Nicolo Bragazza of Morningstar Wealth said Japan is now evolving into a “fundamental story”, driven by improvements in profitability and better capital allocation. Corporate governance reforms are reshaping company operations, and investors are starting to see tangible results.
“Previously a valuation story, Japan is now a fundamental story due to corporate governance reforms. While macro is important, investors must balance it with fundamentals and valuation,” said Bragazza.
Although changes around cross-shareholdings and board structures have accelerated in recent years, Bragazza noted that the effects on profitability and capital allocation are not yet fully visible, adding that “there’s still more to be done” despite the strong long-term potential.
Building on this, Marcus Weyerer said that “the biggest driver is corporate governance”, adding that the theme is still “running” and not yet widely appreciated by investors, which gives him confidence in the outlook. He also pointed to a “virtuous cycle” between inflation and higher wages, saying the pandemic effectively “kick-started inflation for the first time” and helped Japan move out of its long deflationary phase. In sector terms, Weyerer highlighted industrials and financials, alongside IT, though he noted that from an ETF perspective, the IT sector is “relatively small” and not yet a major driver in portfolio implementation. Reforms are now visible “on the ground,” he added, with increasing activist activity and gradual improvements in earnings and returns, adding that these developments are still not fully appreciated by investors.
From a portfolio construction perspective, however, Simon Woodacre said it is important “not to have too much from a macro perspective in terms of exposures,” particularly given currency risks. While some investors may lean into these dynamics, he cautioned that carry trades can “override a lot of these performance points,” with knock-on effects across sectors and styles, making them relevant but not worth overemphasising. He added that macro concerns focus on “unfunded tax liabilities,” which, while different from the UK gilt crisis and “not a significant risk to corporate Japan,” remain worth monitoring, particularly given that Japan’s debt is largely internalised. He described his firm’s approach as relatively sector-agnostic, with more focus on styles, noting that while value has been strong, growth has also performed well recently. This ties into Japan’s role in the AI supply chain—particularly in areas such as optical fibre, assembly and testing equipment—where the secondary effects are more divergent than they first appear.
From an allocation standpoint, Chua said that while “the fundamental arguments are much more attractive,” the opportunity in Japan is “still very much at the beginning,” with significant potential yet to be realised. He noted that active managers “have outperformed” by identifying opportunities “through the lens of corporate governance,” with gains coming alongside governance improvements.
“Japan feels like it’s in a different phase — a shift from its historically under-allocated position in global multi-asset portfolios.”- Francis Chua
He added that strong performance over the past two years raises questions about how much further it can run. Despite maintaining a favourable view on equities and government bonds, he cautioned that momentum-driven positioning can unwind quickly and headwinds must be monitored.
Another element of this shift is return on equity. Historically, Japanese companies have operated with low ROE compared to global peers, reflecting excess cash, conservative balance sheets and inefficient capital allocation. Reforms are now targeting this issue, with companies under pressure to either deploy capital more effectively or return it to shareholders.
This has implications for both profitability and valuations: closing the ROE gap with US peers could drive further rerating, reinforcing how governance reform is reshaping how investors price Japanese equities. With Japan still trading on lower multiples than the US and global investors underweight, improving governance and capital efficiency could strengthen the case for increased allocation.
In this sense, Japan is shifting from a valuation-driven market to one increasingly anchored in fundamentals and capital discipline.
Oshikubo added a caveat and opportunity here. Major Japanese companies still have lower ROE than American and European peers, even after a rise in corporate earnings. But more and more firms are now paying attention to capital efficiency, which is beginning to improve earnings through strategy reviews and sharper business portfolio decisions.
Temperley highlighted that “the biggest potential” in Japan lies in how companies are focusing on ROE. While the return component is already strong, he noted that the main constraint is that “there’s too much E,” meaning balance sheets remain inefficient. Crucially, this is “just beginning to be understood by Japanese corporates,” suggesting that improvements in capital structure and capital allocation could provide upside going forward.
“The biggest driver is corporate governance… the theme is still running and not yet widely appreciated by investors.”-Marcus Weyerer
Decoding the cultural shift
Perhaps the clearest sign of change lies in how Japanese companies think about shareholders now.
Temperley highlighted that three decades ago, dividend policies were static and largely irrelevant. Today, companies actively discuss payout ratios, buybacks and capital allocation strategies—and increasingly seek investor input. “They’ll ask whether I prefer dividends or buybacks,” he said. “Because they know if they don’t, I’ll just buy another company.”
Bragazza said that rising buybacks reflect more than capital allocation; they signal a broader cultural shift. The fact that companies are now asking investors how they prefer distributions shows they “care about what investors think,” which he sees as evidence that governance changes are taking hold. This marks a clear departure from historically passive capital management towards a more shareholder-focused approach.
Temperley noted that “retail flows” into Japanese equities have started to pick up following new highs in the Nikkei, but added that both foreign and domestic investors remain underweight—suggesting there is room for further allocation.
“Now Japanese companies need to change,” Oshikubo said, citing Tokyo Stock Exchange requirements to use cash more efficiently, disclose the cost of capital and improve return on equity. Alongside the unwinding of cross-shareholdings, this has reshaped ownership dynamics, with foreign investors now holding over 30% of the market and increasing pressure on management. Activist proposals are becoming more common, particularly at cash-rich or inefficient firms, and “they have to listen,” he noted. Data shows Japan has become one of the largest activist markets globally, second only to the US.
This has supported a rise in buybacks and dividends, with companies also being pushed towards more strategic capital use, including investment, M&A and restructuring, as governance reforms deepen.
With cash-to-assets ratios still above 10%, there remains significant scope for balance sheet optimisation, Oshikubo said.
He added that the shift in ownership has increased pressure from pure shareholders, forcing greater focus on minority interests and making activist proposals no longer unusual.
“We look at the macroeconomic situation positively, but allocators need to be patient.”-Preksha Shah
“A tightrope”: yen, rates and macro risk
The yen has been a central theme in recent years, with sustained weakness driven by low interest rates and global carry trades. Oshikubo expects this trend to continue in the near term, although he sees a ceiling around the 160 level due to potential intervention.
At the same time, the outlook is far from one-sided.
At its core, the yen story is being driven by interest-rate differentials. With Japanese rates still well below those in markets such as the US, investors have continued to borrow cheaply in yen and invest elsewhere, reinforcing carry trades and putting downward pressure on the currency. Capital outflows, including Japanese investors buying foreign assets, and concerns around expansionary fiscal policy have added to that pressure. As a result, the yen has drifted towards the ¥155–¥160 range against the dollar, with ¥160 widely seen as a ceiling where intervention risks rise. In other words, the current weakness is not just cyclical—it is being reinforced by structural flows and policy divergence.
That said, this dynamic is not set in stone. The debate over interest rates remains central: if the Bank of Japan were to eventually take policy rates above 2%, the gap with other markets would narrow, potentially making the yen more attractive and shifting the balance back towards strength.
Against this backdrop, Temperley said that markets may be underestimating the potential for higher Japanese interest rates. “Conversations with major banks suggest a terminal rate above 2%, which could lead to a significantly stronger yen,” he said, adding that this creates a potential “pain trade”, with markets too comfortable assuming a range-bound yen, while the risk may be skewed towards strength if rates rise more than expected. He also stressed that the Bank of Japan is likely to maintain its independence, with limited scope for political pressure to influence policy.
This uncertainty is reflected in policy challenges. Shah, for instance, highlighted the complexity of the Bank of Japan’s position. “The BOJ has a very tough situation right now,” she said, pointing to cost-push inflation—particularly higher food prices—and geopolitical risks, while also noting the challenge of balancing policy against a potentially more hawkish Federal Reserve and the risk of further yen weakness.
Adding another layer to the outlook, Oshikubo noted that Japan holds roughly half a year of oil reserves, providing a buffer against short-term shocks. However, a prolonged disruption could still push energy prices significantly higher and weigh on growth, although his base case is that prices stabilise within a few months.
At the same time, tighter policy is complicated by the global backdrop—especially if the US Federal Reserve remains hawkish, widening rate differentials and pressuring the yen. Ideally, rate hikes would be driven by demand-led inflation rather than supply shocks, but “it’s a bit of a balancing act.” Taken together, these forces leave the yen caught between opposing pressures: structural weakness in the near term, but the potential for a sharper reversal if policy expectations shift.
As Shah noted, corporate earnings remain highly sensitive to currency moves, raising questions about the durability of recent profit growth.
Oshikubo said yen weakness in recent years has been driven not only by low interest rates but also by structural factors in capital flows. He pointed to low rates encouraging carry trades and rising overseas investment by Japanese households—particularly through tax-advantaged schemes such as Nippon Individual Savings Account (a tax-exemption program for small investments to encourage individuals to shift savings into investments) —adding to sustained outward pressure on the yen. This reflects a broader supply-demand imbalance in the currency, with persistent capital outflows reinforcing depreciation pressures. He also noted that authorities have previously intervened around the ¥160 level, placing a ceiling on excessive weakness.
Japan’s growing “digital deficit,” driven by imports of foreign IT services such as US platforms, has further weighed on the yen. However, Oshikubo suggested this dynamic is not permanent. If confidence improves—particularly around fiscal sustainability—“Japanese institutional investors will come back to the JGB market more and more,” which could support the currency over time. He also highlighted that concerns around expansionary fiscal policy have already pushed bond yields higher and contributed to yen weakness, underlining the important interaction between fiscal policy, yields and currency movements.
As the Takaichi administration pledges to maintain fiscal discipline, Oshikubo expects excessive yen-selling pressure linked to fiscal deterioration concerns to subside. He also argued that caution around potential currency intervention by Japan and the US should help curb excessive weakness, leaving the market more range-bound around the ¥155 level.
He made a point on earnings sensitivity. Japanese manufacturers have steadily increased overseas production since the 1990s, partly to reduce the effect of exchange-rate swings on profits. That means a stronger yen would still matter, but the transmission into earnings is not as straightforward as it once was.
“It is important not to have too much from a macro perspective in terms of exposures, particularly given currency risks.”-Simon Woodacre
“Hidden” opportunities
Weyerer downplayed concerns around passive flows, arguing that ETF activity is “a fraction… of the market” and “not in any way… driving the market” or creating bubble risks. Even in the US, where passive ETF exposure is higher, he noted that volatility linked to ETFs is often overstated—“it’s the ETF that gets blamed,” when in reality investors are simply using liquid vehicles to express views.
According to Bragazza, style remains a key consideration for active investors. While passive allocations remove the need to “worry about the style” by tracking the index, active strategies must navigate shifts between growth and value—particularly given the strong rebound in value post-pandemic. Different styles, he added, offer exposure to distinct themes: value aligned closely with Japan’s corporate reform story, while growth provides access to automation and AI. In that sense, Japan’s market structure—more manufacturing- and hardware-driven than the US—positions it less as a victim of AI disruption and more as a beneficiary of its industrial build-out.
Small and mid cap stocks were a key topic in the conversation.
Shah cautioned that while EPS growth—“especially last year”—has been “exuberant,” investors should question how much is structural versus currency-driven. Yen weakness has boosted earnings and could reverse, so she favours “alpha over beta plays,” noting broader market exposure remains tied to the yen cycle. Instead, her focus is on being selective, particularly within small and mid cap names, which are “less vulnerable to… currency impacts in the short term” and more directly exposed to domestic structural shifts. Corporate reforms still have further to run in smaller companies, said Shah, where there is “more room” for improvement compared to large caps like Toyota, positioning this segment to benefit more from ongoing changes in profitability and capital allocation.
Oshikubo agreed, highlighting that many smaller Japanese companies suffer from limited analyst coverage and lack detailed English-language disclosure. “There are many hidden good companies,” he said, noting that these inefficiencies can be exploited by those with local expertise. At the same time, a large share of small caps remain domestically focused and trade below book value, leaving scope for rerating as governance reforms drive improvements in capital efficiency through buybacks, restructuring and other corporate actions.
The Topix index, the Tokyo Stock Exchange’s main benchmark, is set to shrink from around 1,700 to 1,200 companies by 2028, increasing pressure on small and mid caps to improve capital efficiency and valuations, potentially driving further corporate action.
Diversification benefits stem from their low correlation with US equities, partly because they are less represented in major indices and less heavily owned by foreign investors.
Oshikubo added that small caps have delivered stronger earnings growth than large caps, supported by niche business models and a rise in IPOs since 2000 in higher-growth sectors such as technology, retail and services.
While many Japanese companies still have strong competitive positions, pressure from China is starting to build, Woodacre said. Sectors where firms have established moats should hold up well, but in other areas, competition is picking up, and reliance on Chinese demand adds some vulnerability.
While AI will create both winners and losers, Temperley said that the market is focused on how AI could “replace a number of these previously important industries,” but emphasised that Japan’s strength lies in manufacturing and hardware.
Historically, the dominance of English gave US software giants such as Microsoft and Amazon a structural advantage, limiting Japan’s role in that space. However, in what Temperley described as a “decade for AI,” countries with strong industrial and manufacturing capabilities are likely to benefit most, positioning Japan as a relative winner in the build-out phase of AI.
For investors, the message is clear: Japan’s long-awaited shift may still be in its early stages, but momentum is building, and with opportunities ranging from small caps to semiconductors, there are plenty of ways to play it.
