- Good afternoon, Aliya! Please share with our readers the peculiarities of Japan's economic development.

- Good afternoon! With pleasure! It’s common knowledge that Japan plays an important role in the global economy. As of the end of 2023, the country ranks second in the world in terms of gold and foreign exchange reserves, and is also among the top four in terms of GDP.

The GDP growth in the first two quarters of 2023 was stable, mainly due to growth in exports of services and domestic consumption. Despite GDP declines in the third and fourth quarters of the previous year, which implies that Japan's economy is entering a technical recession, amid weaker domestic demand, Japan's GDP growth rate is expected to moderate from the second quarter of this year on the back of rising consumer spending, capital investment, digitalization and supply chain re-orientation. It should be noted that the accumulated cash reserves of Japanese companies may indicate a high appetite for capital investment. Japanese government adopts numerous reforms to improve domestic productive efficiency and global competitiveness.

In 2023, Japan's inflation rate hit its highest level since the 1980s for the first time and exceeded the Bank of Japan's 2% target, which was welcome news for an economy that had been stagnant for a long period of time. The supply chain disruptions and geopolitical conflicts have caused higher import prices for food and energy products, followed by inflation growth. Inflation and economic growth are expected to be supported by rising service prices, tight labor market, as well as economic policies aimed at sustainable economic growth. In the spring of 2024, the labor unions and Japanese companies are expected to negotiate wage increases, which may contribute to an increase in the purchasing power and household expenditures. It should be noted that the 3.6% increase in total wages in spring 2023 was the largest since 1993.

Bank of Japan is expected to take the first step toward monetary policy normalization in the spring of 2024, and move away from negative rates. However, it is not excluded that the internal and external factors may affect the continuation of ultra-soft monetary policy. The earthquake earlier this year in the Noto area in northern Ishikawa Prefecture is one such example. Even though in this case, preliminary estimates of GDP loss do not exceed 0.01% of Japan's GDP for 2022, at that time, the markets' expectations on the future course of the Bank of Japan were ambiguous.

- Please share how do you assess the current development of equity markets in Japan?

- In general, Japan's stock indices show positive dynamics amid growing investor activism, international capital flows and lackluster performance of the Chinese stock market. In 2023 and from the beginning of 2024, TOPIX has demonstrated positive dynamics and grew by 25% and 15% respectively. The trends of Japanese corporate revenue remain quite strong. In general, for the third quarter of 2023, 86% of Tokyo Stock Exchange companies reported a 47% increase in net income, and the companies' aggregate net income was 11% above consensus forecasts. The stock market growth in 2024 is expected to be driven by structural growth and recovery in the electrical appliances, automobiles & parts, raw materials & chemicals, and machinery sectors, as well as in the area of information and communication technologies.

- Can you please tell us about the current investment trends in Japan?

- It is worth highlighting four major areas in Japan's capital markets in 2024 actively monitored by market participants. The first area affects the modernization of the Japanese corporate governance model. The efforts by the Tokyo Stock Exchange to enhance market stability and improve shareholder returns, are attracting the attention of investors around the world. In early 2023, the Exchange published requirements for all companies below book value to implement corporate governance reforms. It is worth noting that at the beginning of 2023, more than half of the companies on the Tokyo Stock Exchange were trading at a price-to-book value ratio below 1.0x, in light of the highly competitive environment and low profitability of companies. However, the share of Japanese companies in the TOPIX with P/B ratios above 2.0x was 23% vs. 72% of the U.S. companies in the S&P 500 Index. Therefore, in 2023, the Tokyo Stock Exchange began to actively pay attention to Japanese companies whose shares are trading below book value, to increase return on equity, improve labor productivity and revise the calculation of the cost of capital. The pressure from the stock exchange on Japanese corporations in terms of reporting has partially caused the share of companies with P/B ratios below 1.0x to decline from 52% at the beginning of 2023 to 46% at the end of 2023.

The second area of concern is the high level of interconnection of corporations through cross (joint) ownership of shares. The cross-shareholdings were considered a crucial problem of corporate governance in Japan. Dissolving «family» corporations and reducing co-ownership shares has been in the high light over a long period of time. However, following the 2018 amendments to the Corporate Governance Code and then in 2023 following the introduction of a number of requirements by the stock exchange to increase management's awareness of the cost of capital and share price movements, the trend towards lower joint ownership of company shares has gained steam. The investors view companies' statements on the termination of cross-shareholdings as an important indicator of improved corporate governance.

The third trend in Japan's stock market involves a rebound in the share prices of fast-growing small-capitalization companies driven in part by increased participation of retail investors in the Japanese stock market, corporate reforms and a recovery in domestic economic growth.

And the fourth is the NISA system, or the Nippon Individual savings account. This system has been in place since 2014 to provide tax incentives for individuals' investment activities in Japan, and exempts investment income of individual investors from taxation. In the long term, it is expected that the expanded NISA system encourages public participation in Japanese stock market instruments.

-  Aliya, we have covered the main trends in Japan's stock market, and what trends can be identified in the private markets?

- Japan's private equity market is becoming more sought after by international investors. Japan's capital markets have seen a steady inflow of foreign investment which is due to increased control of the companies’ activity following the introduction of the Corporate Governance Code, weakening of the yen and increased geopolitical risks.

The aging population is a major challenge for Japan and raises concerns for Japanese companies about the transfer of succession rights and heritage preservation. The demographic changes present opportunities for fund managers who provide solutions to restructure, add value to companies, and assist in the smooth transfer of ownership rights. Furthermore, the Japanese corporations seek to increase capital management efficiency by optimizing their operations and business processes.

It's worth noting that assets under management of Japanese private equity funds have tripled over the past 10 years to reach about $46.3 billion at the end of 2022. According to a study conducted by the Japan Private Equity Association (JPEA), the internal rate of return (IRR) of surveyed funds for the 10-year period was 22.2% from 2012 through 2021, compared to the TOPIX index return of 9.2% over the same period.

The volume of transactions in the M&A market has been growing strongly in Japan since the beginning of 2023. The number of private equity fund deals in Japan roughly doubled in the first nine months of 2023, compared to declines of around 20% in the US and in Europe. An example of the largest M&A deal in Japan in 2023 is the acquisition of Toshiba electronics manufacturer by the Japan Industrial Partners (JIP) fund. Last september, the Toshiba has announced the successful completion of a $14 billion tender offer by the JIP fund. The transaction is indicative of the growing role of the private equity market in Japan, where the value of assets is low. The private equity funds can revitalize underperforming companies through strategic decisions and targeted capital investments.

Also, the Japanese institutional investors make investments in the alternative investment market. University of Tokyo Endowment Fund plans to increase the share of private equity and real estate to 60% of its portfolio. The Japanese institutional investors, which include the Government Pension Investment Fund of Japan (GPIF), increase global investment in alternative asset classes, such as private equity, real estate and infrastructure.

The venture capital also has a high potential for development in Japan. The state policy aimed at supporting the startup ecosystem, including the corporate tax incentives for the development of innovations, contributed to the growth of the attractiveness of venture capital. The positive environment for startups has spurred a wave of so-called corporate venture capital (CVC) funds in Japan. It is worth noting that assets under management of venture capital funds in Japan have grown almost 10-fold from $4.6 billion in 2012 to $46.2 billion in 2022, and also correspond to the amount of assets in the Japanese private equity market.

I would also like to highlight hedge funds with a focus on Japan, which are active on the stock market and also demonstrate positive profitability indicators. Japan-focused hedge funds also demonstrated less drawdown during market corrections.

- Aliya, what risks can you emphasize when considering Japan?

- Japan's economic renovation and improvement of corporate governance standards are at an early stage. One of the main problems faced by Japan is the high level of public debt. However, corporate profitability is expected to remain robust in the short term owing to soft currency, a recovery in tourism activity, corporate capital investment and long-term structural changes. The upcoming 2024 will be a key year. The normalization of the monetary policy, changes in consumer and corporate activity coupled with a shift from deflationary to inflationary effects, are likely to have a positive long-term effect on enterprises and contribute to a positive investment climate and economic growth.

- Thank you, Aliya, for the insightful talk, and wish you the best of luck!