What Your Consultant Is Saying About…Japan

(March 16, 2011) — As Japan’s nuclear crisis intensifies following last Friday’s earthquake and tsunami, contrarian investors are prepared to embrace renewed market volatility, which they view as an opportunity to buy Japanese equities. The majority of consultants, however, have been skeptical about investing in the area for some time, warning their clients to flee from equities in the region until major policy changes occur.

“Equity investors have suffered quite a few hits — the bursting of the tech bubble, the global financial crisis, issues in the Middle East with sharp jumps in energy prices, and now the growing catastrophe in Japan,” consultancy LCG Associates Vice President Britt Bentley tells aiCIO. “All these events have created volatility in the marketplace,” he says. “Uncertainty in markets tends to not support market growth.”

In the mid 1990s, Japanese equities were at their peak of attractiveness, comprising nearly 50% of the world equity market. Today, that percentage is down to around 10%, and it will likely continue its downward trend following the crisis in the region, fueling the potential implosion of Japan’s economy caused by an aging population and rising fiscal deficits, according to Matt Stroud, head of strategy and portfolio construction at Towers Watson. “Japan really needs fiscal reforms, and the recent catastrophe could be the impetus the country needs to achieve major policy changes to foster rising confidence in the Japanese economy,” he tells aiCIO. “When the long-term policy outlook for Japan improves, it will be time to take a fresh look at Japan.”

In response to fears of volatility over Japanese equities, investors are likely to continue fleeing toward safer assets, such as cash, stable currencies, and government bonds, sending bond prices up and causing Treasury yields to plunge. “When you see rates go down like that, it will be good news in the short-term for investors pursuing a liability-driven investing (LDI) strategy,” LCG Associates’ Bentley says. “But short-term changes in treasury rates won’t impact a long-term LDI plan.”

Some consultants say that the situation in Japan speaks to the value of active equity managers, who seek to make decisions based on their assessment and analysis of events. “There are a couple of ways you could look at the crisis in Japan,” notes Tim Barron, president and CEO of Rogerscasey. “Investors could view the situation in Japan as having areas of opportunity or they could choose to stay out of the way — people sometimes run from volatility and sometimes they embrace it,” he says. “Our position is to help clients select active managers who get paid to make those kind of decisions in regards to owning markets like Japan.”

For the past decade, Japan’s marketplace has been faced with a number of negative underpinnings that have created growing concerns about investing in the region, and US investors have been curtailing their investments into the area. Thus, for most US investors, the crisis in Japan will not have a large and immediate impact on their portfolios. Most US investors have below-market exposures to Japan, with a broader non-US or global commitment as opposed to a Japan-only mandate. “When we look at that part of the world, it’s easier to be bullish on China than Japan,” Barron says, describing China’s double-digit growth as Japan has suffered from stagflation. Crisis in Japan may lead to accelerated growth in China and continued expansion in other emerging markets, he believes.

On a micro level, investment consultants see opportunity in deploying capital to sectors in the Japanese economy that will participate in the rebuilding efforts, specifically in the areas of residential and commercial replacement of lost infrastructure. “But its still too early to tell,” Stroud says. “We’re still assessing the damage.”