The economic backdrop
Conditions are steady. This year's spring wage negotiations are pointing to pay rises of around 5% at larger companies, suggesting some real income growth, particularly for younger workers. Not all parts of the economy are benefiting equally, but the direction of travel is constructive.
Bond markets and the carry trade
Perhaps more consequential for global investors is what is happening in Japanese bond markets. Long-dated Japanese government bond yields have risen meaningfully from the ultra-low levels of the past decade and that shift is beginning to change behaviour. Hedging overseas assets back into yen has become more expensive, reducing the appeal of the well-known carry trade that has historically seen Japanese institutions deploy large amounts of capital abroad. While any repatriation of that capital is likely to be gradual, Japan could become a less dominant provider of global liquidity over time. That, in turn, may support a firmer yen and subtly alter the risk dynamics of global fixed income markets.
Corporate governance reform
Japan continues to push companies to justify large cash balances and improve capital efficiency. Many firms still hold substantial excess cash relative to their operational needs. Regulatory and stock exchange initiatives are encouraging better capital allocation through higher dividends, share buybacks or more productive investment. Progress has tended to be incremental rather than dramatic, but even modest improvements can materially enhance shareholder returns over time. For an income-focused strategy, this steady uplift in payout potential this creates is particularly attractive.
Portfolio positioning
The WS Zennor Japan Equity Income Fund maintains meaningful exposure to smaller and mid-sized businesses, many with predominantly domestic earnings, where governance improvements can drive significant change and where balance-sheet strength underpins resilient income. The portfolio has also seen a gradual increase in exposure to businesses with strong cashflow growth characteristics, blending balance-sheet value with improving profitability. On the operational side, the team has added research resource and enhanced their trading capabilities - particularly important in Japan's under-researched smaller company universe.
T. Bailey’s view
Japan may not always command headlines in the way other markets do, but it currently offers a combination of improving governance, sensible valuations, rising income potential and a more decisive political environment than it has seen for many years. In a world where many developed equity markets appear fully valued, that steady and often underappreciated progress remains a compelling part of a diversified portfolio.
