Investing in Japan: The Tokyo Stock Exchange Revival

Japan's equity market spent three decades as a byword for investment frustration. The Nikkei 225 index peaked at nearly 39,000 in December 1989, collapsed in one of the most dramatic asset price busts in modern financial history, and spent the following 34 years below that level — finally recovering to record highs only in early 2024. For a generation of investors, Japan was a graveyard of capital and optimism: high quality companies, reasonable valuations, but seemingly immovable structural impediments to shareholder value creation.

Something has changed. The Tokyo Stock Exchange's corporate governance reform campaign, accelerating from 2023 onwards, has begun to unlock value that has been trapped in Japanese corporations for decades. Warren Buffett's headline investments in Japanese trading companies from 2020 onwards drew global investor attention to a market that had been systematically underweighted in international portfolios. Institutional flows, activist investors, and rising domestic inflation are all combining to push Japanese corporate culture in a more shareholder-friendly direction.

As of 2026, Japan offers arguably the most attractive combination of value and reform momentum of any major developed market. This article explains the opportunity, how to access it, the specific characteristics of Japanese equity investing, and the risks that remain. Nothing here constitutes personal financial advice; seek professional guidance before investing.

Why Japanese Equities Were Neglected

Understanding the opportunity requires understanding why Japan underperformed for so long.

Cross-shareholding (keiretsu): Japanese companies traditionally held shares in their suppliers, partners, and customers — and those companies held shares back. This web of mutual ownership meant that shares were held by friendly, patient hands unwilling to press management for better returns. Management could prioritise growth, employment stability, and relationships over profitability without fear of shareholder challenge.

Cash hoarding: Japanese companies accumulated enormous cash reserves, often exceeding their entire market capitalisation. A company worth USD 1 billion on the stock market might hold USD 1.2 billion in cash and securities — a situation unique to Japan among major economies. From an investment perspective, you were effectively buying the assets at a discount but handing control of the cash to management that would not return it.

Low return on equity: The combination of cross-shareholdings, excess cash, and cultural aversion to financial engineering meant that Japanese companies consistently generated lower returns on equity (ROE) than their Western peers. Japanese large-cap ROE averaged approximately 5–7% versus 12–15% for US large caps.

Deflation and demographics: Japan's experience of persistent deflation from the late 1990s created a headwind for earnings growth and discouraged risk-taking. An ageing, shrinking population compounded the structural challenge.

Governance culture: Management accountability to shareholders was weak. Boards were dominated by insiders. Independent directors were uncommon. Shareholder proposals were easily defeated.

All of these factors meant that excellent underlying businesses — Toyota, Sony, Hitachi, Keyence, Shin-Etsu Chemical, Murata Manufacturing — traded at significantly lower valuations than equivalent Western businesses.

The Governance Reform Catalysts

Tokyo Stock Exchange Pressure

The Tokyo Stock Exchange's most consequential intervention began in earnest in 2023: companies trading at below 1x price-to-book ratio were required to disclose and implement plans to improve their valuations. This affected roughly half of all TSE Prime Market companies — an extraordinary proportion.

The requirement to "explain or improve" created immediate pressure on boards to take action. Responses have included:

• Unwinding cross-shareholdings: Selling shares held in partner companies and returning proceeds to shareholders
• Share buybacks: Companies with excess cash began buying back their own shares at scale
• Dividend increases: Payout ratios, historically very low in Japan, are rising across a broad range of companies
• M&A and restructuring: Spinoffs, mergers, and asset sales to focus on core businesses and improve returns on capital
• Board reform: Appointment of independent directors, outside CEO candidates, and more diverse boards with genuine oversight mandates

These changes are real and measurable. Share buybacks in Japan reached record levels in 2023 and 2024. Dividend increases are widespread. Cross-shareholding unwinds are accelerating. Return on equity is rising. The process has further to run.

Domestic Inflation and the End of Deflationary Mindset

Japan experienced genuine inflation — above 2% CPI — from 2022 onwards for the first time in decades. The Bank of Japan, after years of extraordinary monetary stimulus, began tentatively normalising policy in 2024, raising short-term interest rates for the first time since 2007. This "normalisation" of the monetary environment has significant implications:

• A steeper yield curve incentivises banks to lend (rather than parking excess reserves with the central bank), improving banking sector profitability
• Nominal earnings growth becomes genuinely positive for many Japanese companies with pricing power
• Real assets (property, equity) become relatively more attractive versus deflation-depressed cash

The end of the deflationary mindset is perhaps the most important structural shift — Japanese households and companies are increasingly willing to invest and spend, rather than hoard cash in anticipation of lower prices.

Buffett's Investment and Global Attention

Warren Buffett's Berkshire Hathaway began investing in five major Japanese trading houses (Itochu, Marubeni, Mitsubishi, Mitsui, and Sumitomo) from 2020, eventually accumulating stakes of 7–9% in each. In a country where activist foreign investors had historically been greeted with hostility, Berkshire's patient, value-oriented approach and long-term commitment was received positively.

The investments generated significant media attention and, more importantly, drew sophisticated institutional capital to a market it had underweighted. Japanese equities became a major investment theme in 2023 and 2024, with ETF inflows, hedge fund allocations, and value investor repositioning all flowing into the market simultaneously.

The Current Opportunity Set

Valuation

Japanese equities remain attractively valued in both absolute and relative terms. The TOPIX index trades at approximately 14–16x forward earnings as of mid-2026, a significant discount to US equities (20–22x) and broadly in line with European markets. Price-to-book ratios, while rising, remain below 2x for many high-quality companies — still implying that investors are not paying much above the book value of assets.

For active investors, the opportunity lies in identifying companies where the governance improvement journey is underway but not yet fully valued — companies that have begun unwinding cross-shareholdings and buying back shares but where the full effect of these actions has not been reflected in market prices.

Sector Opportunities

Automotive: Toyota, Honda, Subaru, and Mazda face the global electric vehicle transition from positions of financial strength. Toyota's hybrid leadership and manufacturing excellence position it well; its EV strategy remains debated. The supply chain around Japanese auto manufacturers — specialist component makers in precision electronics, materials, and braking systems — has significant competitive depth.

Electronics and semiconductors: Japan's dominance in specific semiconductor-adjacent materials and equipment is world-class. Shin-Etsu Chemical (silicon wafers), Tokyo Electron (semiconductor manufacturing equipment), and Disco Corporation (precision cutting equipment) are globally irreplaceable links in the semiconductor supply chain that is the foundation of AI and modern technology.

Industrial machinery: Companies such as Keyence (factory automation sensors and vision systems), Fanuc (industrial robots), and SMC Corporation (pneumatics) are global leaders with high margins, strong cash generation, and irreplaceable technology positions.

Financial sector: Japanese banks were deeply depressed valuations for most of the low-rate period. Rising interest rates have begun to improve net interest margins at Mitsubishi UFJ Financial Group, Sumitomo Mitsui Financial Group, and Mizuho. Life insurance companies benefit from a steeper yield curve. Financial sector valuations remain below book in several cases.

Trading houses (shosha): The five companies Buffett invested in are diversified conglomerates with exposure to commodities, logistics, finance, infrastructure, and consumer businesses globally. Their growing commitment to shareholder returns and improving governance makes them an unusual combination of value and quality.

The Activist Investment Opportunity

Activist investing in Japan — once politically toxic — is becoming more mainstream. Domestic activists (Oasis, Murakami Fund) and international investors (Elliott Management, Dalton Investments) are increasingly able to engage constructively with management to unlock value. Foreign investors with specialist knowledge of Japanese corporate governance can potentially generate above-index returns by identifying companies where activism can accelerate the reform process.

This strategy is most accessible through specialist Japan-focused active funds rather than through individual stock selection by non-specialist investors.

Currency Considerations: The Yen

The Japanese yen experienced a dramatic depreciation from 2021 to 2024, falling from approximately 110 yen/dollar to 155–160 yen/dollar — its weakest level in decades. From a foreign investor's perspective, this depreciation reduced the dollar and sterling returns on Japanese equity investments, even when underlying yen-denominated returns were strong.

The yen's trajectory from 2026 is uncertain. Arguments for yen strengthening include: the Bank of Japan's monetary normalisation (higher Japanese interest rates reduce the interest rate differential that was driving yen weakness), Japan's large current account surplus, and potential risk-off flows (the yen has historically strengthened in global crises, serving as a safe haven currency).

Foreign investors in Japan must decide whether to hedge their yen exposure back to their functional currency or accept currency risk as part of the investment. Currency hedging costs money (dependent on the interest rate differential between the yen and the hedging currency) and requires active management.

Risks

Reform Fatigue or Reversal

Japan has attempted governance reform before (the Abe-era Stewardship Code of 2014) with limited lasting effect. There is genuine uncertainty about whether the current reform momentum is structural or whether the pace of change will slow as large cross-shareholding unwinding creates indigestion in equity markets.

Demographics

Japan's population is shrinking and ageing. This is a structural drag on domestic consumption, housing, and service-sector growth. The labour shortage is severe in many industries. Immigration policy has been cautious, limiting the population-growth offset that other ageing economies have pursued.

Geopolitical Risk

Japan's proximity to North Korea, its territorial disputes with China and Russia, and its US defence alliance create geopolitical risks. The Taiwan Strait situation — relevant to Japan's security given its proximity — is a significant tail risk for Japanese equities, though also for global markets generally.

Export Sensitivity

Japan's export-oriented economy is sensitive to global growth, US and Chinese demand, and exchange rate movements. A global recession would affect Japanese manufacturers significantly, as would specific trade tensions between the US and Japan's major trading partners.

Accessing Japanese Markets

• Global equity ETFs: Most global equity index funds include Japan (approximately 5–7% of MSCI World). This provides passive Japanese exposure without requiring a deliberate allocation decision.
• Japan-specific ETFs: iShares MSCI Japan ETF, WisdomTree Japan Equity ETF (currency hedged), and numerous others allow deliberate overweighting of Japan.
• Actively managed Japan funds: Several respected fund houses manage Japan-focused UCITS funds with strong long-term records and genuine research expertise.
• Direct investment via Japanese brokers: Not practical for most international investors.

How Global Investments Can Help

Japan's equity market opportunity requires both conviction and patience — the reforms are real but gradual, and the yen's trajectory adds complexity for international investors. At Global Investments, we help clients assess whether a deliberate Japan overweight is appropriate for their portfolio, identify the most suitable access vehicles, and manage currency exposure within their overall foreign exchange framework.

This article reflects information available as of mid-2026. Japanese market conditions, corporate governance developments, and Bank of Japan policy may change materially. Nothing here constitutes personal financial advice. Investments can fall as well as rise. Seek professional advice before investing.