Japan Equities in 2026: The Structural Change Story

Japan's stock market spent thirty years as the world's most prominent cautionary tale. The Nikkei 225 peaked at 38,915 in December 1989, collapsed, and did not reclaim that level until February 2024 — thirty-four years later. For many investors, Japan became synonymous with asset bubbles, deflationary traps, and the futility of buying expensive markets.

The structural change that has begun is real, well-documented, and — for international investors willing to engage with the complexity of yen exposure — worth understanding carefully.

The lost decades: a brief history

Japan's 1980s asset bubble was one of the most extreme in financial history. At its peak, the land under the Imperial Palace in Tokyo was theoretically worth more than the entire state of California. When the bubble burst in 1990, the consequences were severe and prolonged: corporate Japan was loaded with bad debt, banks refused to write off non-performing loans, "zombie companies" were kept alive by cheap credit rather than allowed to restructure, and deflation became entrenched. When prices are expected to fall, consumers postpone spending and companies delay investment — a self-reinforcing trap that Japan could not escape for decades.

The Bank of Japan's response — first zero interest rates, then quantitative easing, then "yield curve control" — ultimately failed to generate sustained inflation until the global inflationary episode of 2022-2023, which imported price pressure even into Japan.

The Tokyo Stock Exchange reforms

The turning point for Japanese corporate behaviour came not from monetary policy but from the Tokyo Stock Exchange. In 2023, the TSE's Prime Market (the top tier, home to Japan's largest companies) issued a directive requiring listed companies with a price-to-book ratio below 1.0x to develop and disclose plans to improve their valuation.

This was significant because a substantial portion of Japanese listed companies — including many large, cash-rich industrial groups — traded below book value. In any other major market, this would have attracted activist investors demanding restructuring. In Japan, cross-shareholdings (companies holding each other's shares as relationship capital), management entrenchment, and cultural norms had protected undervalued companies from accountability for decades.

The TSE's reform, backed by the Japan Corporate Governance Code, began to change this. Companies started announcing buyback programmes, dividend increases, sales of non-core assets, and disposals of cross-shareholdings. Return on equity — historically very low by international standards — began to improve across the index. By 2024, foreign institutional investors took notice and rotated into Japanese equities at scale.

Berkshire Hathaway and the sogo shosha

Warren Buffett's investment in Japan's five major trading conglomerates — Itochu, Marubeni, Mitsubishi, Mitsui, and Sumitomo — began in 2020 and was expanded significantly in subsequent years. Buffett funded the investments partly by issuing yen-denominated bonds, creating a natural currency hedge.

The thesis was straightforward: these companies were trading at deeply discounted valuations, paying strong dividends, were well-managed, and were beneficiaries of a commodity supercycle. Crucially, Buffett's endorsement sent a signal to the global investment community. If Berkshire Hathaway, the world's most famous value investor, was buying Japan, the structural opportunity was perhaps more compelling than its reputation suggested.

The sogo shosha investment is not directly replicable for most investors, but the broader Japan re-rating that followed is accessible via index funds and active managers.

Japan exiting deflation: the macro shift

After decades of trying, Japan has begun to exit deflation. Consumer price inflation reached 3-4% in 2023, above the Bank of Japan's 2% target for the first time in a generation. Wage growth — historically anaemic in Japan — began to pick up, with major companies agreeing to the highest wage increases in thirty years during the 2024 "shunto" (annual wage negotiation process).

This matters for investors because deflation suppresses earnings growth and corporate investment. When companies expect prices to rise, they invest, hire, and grow. When they expect prices to fall, they hoard cash. Japan's transition from deflationary psychology to a more normal inflationary environment is one of the most significant macro developments in any major economy in recent years.

The Bank of Japan responded by gradually exiting its ultra-loose monetary policy, raising rates from zero for the first time since 2007. This caused significant market volatility in mid-2024 when the BOJ's rate rise triggered a sharp unwinding of yen carry trades. Understanding this dynamic is important for investors in Japan.

The yen: risk and opportunity combined

For international investors, the Japanese yen is the central variable in any Japan investment. In 2023-2024, the yen reached historic lows against the US dollar and British pound — at points exceeding 160 yen per dollar, levels not seen since the 1980s.

The weak yen was driven by the interest rate differential between Japan (near zero) and the US and UK (5%+). Investors borrowed yen cheaply to buy higher-yielding assets elsewhere — the "carry trade." When the BOJ raised rates, carry trades unwound rapidly, causing the yen to strengthen sharply in a short period and triggering equity market volatility.

For a UK investor without currency hedging, the yen situation presents a distinctive opportunity. When you invest in Japan today at historically weak yen levels, you are effectively buying Japanese equities and Japanese yen at the same time. If the yen normalises towards its long-run purchasing-power-parity fair value — which most currency models suggest implies significant yen appreciation versus the pound and dollar — you benefit from both equity appreciation and currency appreciation simultaneously.

This is not a guaranteed outcome; currency normalisation can take years or not happen at all on any given timeframe. But the asymmetry is notable: yen downside from already-historic lows is likely limited, while yen upside from normalisation could be substantial.

Currency-hedged Japan ETFs are available for investors who wish to take equity exposure without the yen dimension. These typically have a slightly higher cost than unhedged equivalents, and the hedge itself may erode returns if the yen strengthens.

Japanese REITs (J-REITs)

Japan has a well-developed listed real estate investment trust market. J-REITs were established in 2001 and today comprise around 57 listed vehicles covering office, retail, logistics, residential, and diversified property. The Tokyo office market in particular is a globally significant investment destination.

J-REITs have historically offered above-average dividend yields by Japanese standards, and their assets are supported by Tokyo's status as a global business hub with strong long-term demand for quality space.

Rising interest rates have created headwinds for J-REITs — as with REITs globally, their long-duration cash flows become less attractive when discount rates rise. However, if Japan's normalisation process stabilises interest rates at a level still low by international standards (which many expect), J-REITs could recover to offer an attractive combination of income and capital appreciation.

J-REITs are accessible to international investors via the iShares Japan REIT ETF and several active funds focussed on Japanese real estate.

The Japan small-cap opportunity

Large-cap Japan is well-covered by international analysts. The small-cap universe is significantly less researched, creating greater potential for active management to add value. Japanese small-cap companies are often highly specialised "hidden champion" businesses — global leaders in niches that international investors rarely examine.

Japan's small-cap market includes world-class manufacturers in precision engineering, automation components, medical devices, and speciality chemicals. Several specialist small-cap Japan managers — including Baillie Gifford's Japan Small Companies Fund and Nippon Active Value Fund — have built strong track records by identifying these undervalued specialists.

Small-cap Japan carries higher liquidity risk and higher volatility than large-cap, but for investors seeking differentiated exposure beyond the Nikkei 225, it represents a genuinely distinct opportunity.

How to invest: the practical options

TOPIX ETFs. The TOPIX (Tokyo Price Index) covers a broad universe of TSE-listed companies — approximately 1,700 following its phased restructuring. It is a far broader representation of the Japanese market than the Nikkei 225, which covers only 225 companies selected by price-weighting. UCITS-compliant TOPIX ETFs are available from iShares, Xtrackers, and Amundi on European exchanges.

Nikkei 225 ETFs. The Nikkei 225 is Japan's most widely followed index internationally, though its price-weighting methodology creates distortions. ETFs tracking it are available from multiple providers.

Active Japan-focused funds. Managers such as Baillie Gifford Japan Trust, Fidelity Japan Trust, and Man GLG Japan CoreAlpha have demonstrated that active management can add value in the Japanese market, particularly through the corporate governance transition. Expense ratios are higher than passive ETFs.

Japan small-cap. Specialist small-cap Japan funds provide exposure to less-covered segments where active management is most likely to generate excess returns.

The appropriate allocation to Japan for an international investor depends on existing portfolio composition. Japan represents approximately 5-7% of the MSCI World Index, providing natural baseline exposure through a global equity fund. An explicit Japan overweight — via a dedicated Japan ETF or fund — is a conviction call on the continuation of the corporate governance reform story and yen normalisation.

How Global Investments can help

Our team works with international investors across currencies and jurisdictions to assess Japan's role in a diversified portfolio. Whether you want passive exposure via a low-cost TOPIX ETF, active management through a specialist Japan fund, or J-REIT income alongside broader equity exposure, we can help you structure a Japan allocation appropriate for your tax situation, investment horizon, and currency base. Contact us to discuss your international equity strategy.