An International, Growth-Oriented Tilt in Japanese Equities

The Hennessy Japan Fund Portfolio Managers discuss the Fund’s positioning given the tariff situation, as well as interest rates, yen depreciation, wage hikes, significant portfolio changes, valuations, and what they will be watching over the remainder of the year. 

July 2025
  • Masakazu Takeda
    Masakazu Takeda, CFA, CMA
    Portfolio Manager
  • Angus Lee
    Angus Lee, CFA
    Portfolio Manager

Key Takeaways

»    The Fund is strategically positioned to weather the ongoing shifts in global trade dynamics and tariff policies.
»    The BOJ’s interest rate decision is not expected to significantly alter the Japan’s near-term economic growth projections.
»    While a weaker yen continues to benefit exporters by enhancing overseas earnings when repatriated, many leading Japanese firms have evolved to operate in a more currency-neutral and globally integrated manner.
»    Sustained wage growth could enhance domestic demand, strengthening globally oriented Japanese businesses’ home market while their international operations benefit from increased investment and profitability.
»    Long-term valuations in Japan appear more reasonable and grounded compared to the U.S. and Europe.
»    For the remainder of 2025, we expect a cautiously optimistic environment for Japanese equities.

How is the Fund positioned given the shifting global trade and tariff situation? What companies could be positively or negatively impacted?

The portfolio was deliberately constructed to mitigate first-order impacts from tariff-related disruptions. This has been achieved through three primary approaches: exposure to service-based companies, emphasis on high-margin businesses, and investments in firms with integrated supply chains. For example:

•   Indeed, the online job search platform owned by Recruit Holdings Co., Ltd., operates in the service sector and appears largely insulated from tariffs on physical goods.

•    Keyence Corp., a leader in factory automation sensors, stands to potentially benefit from onshoring trends in the U.S., as its products are in demand from domestic manufacturers looking to improve productivity and reduce dependence on overseas suppliers.

•    Similarly, Shin-Etsu Chemical Co.Ltd., operates production facilities in North Carolina, giving it a fully integrated U.S. supply chain even in a typically commoditized industry—this may significantly reduce its exposure to cross-border trade frictions.

While the portfolio may include a few companies with more traditional manufacturing exposure that could face localized challenges, the broader composition—marked by geographic diversification and global operations—offers a natural hedge. Many of the Fund’s holdings generate revenues across multiple regions and are well-managed with a strong track record of navigating supply chain and regulatory complexities. As such, we believe the Fund remains resilient and well-aligned to manage both current and future shifts in global trade and tariff environments.

How does the recent action by the Bank of Japan (BOJ) to keep interest rates unchanged impact growth projections for the Japanese economy?

The BOJ’s interest rate decision is consistent with its cautious approach to monetary normalization. This action is not expected to significantly alter the overall growth projections for the Japanese economy in the near term. Japan has experienced negative real interest rates for years, and this environment has already been factored into economic forecasts.

By keeping rates low, the BOJ aims to avoid stifling early signs of growth, particularly domestic consumption, which remains sensitive. The accommodative stance helps maintain stability and supports businesses, reinforcing gradual economic momentum. While global trade disruptions and geopolitical uncertainty may delay the interest rate normalization, it remains the likely long-term path.

How has the sensitivity to the depreciation of the Japanese yen changed over time for Japanese companies?

Over time, Japanese companies—particularly those with international operations—have significantly reduced their sensitivity to yen depreciation. While a weaker yen continues to benefit exporters by enhancing overseas earnings when repatriated, many leading Japanese firms have evolved to operate in a more currency-neutral and globally integrated manner.

In addition, top-tier Japanese companies often align revenues and expenses within the same currency and focus on high-margin products and services, allowing them to absorb adverse currency moves more effectively. These companies also have a long track record of navigating global financial environments through careful hedging and cashflow management.

Overall, while the yen continues to act as a global funding currency, the direct impact of its depreciation on corporate earnings has diminished for many firms. This reflects a strategic shift toward building inherently resilient, well-managed global businesses that are less exposed to currency volatility and better equipped to operate in a range of macroeconomic conditions.

What impact could recent wage hikes have on the Japanese consumer and globally oriented businesses?

The recent wage hikes, the highest since 1992, have the potential to significantly impact both Japanese consumers and globally oriented businesses. If these salary increases become sustainable and are supported by real wage growth, they can boost household confidence in future income prospects. This confidence is crucial to creating new consumer demand, which can lead to what is known as “good inflation”—a moderate inflation that fuels a virtuous cycle where increased consumption supports prosperous businesses, which in turn can raise wages further, fostering even more spending.

For globally oriented Japanese businesses, sustained wage growth can enhance domestic demand, strengthening their home market while their international operations benefit from increased investment and profitability. Moreover, if the BOJ successfully implements a careful interest rate normalization, this could help eliminate inefficient “zombie” companies, improving overall economic productivity. This healthier economic environment is likely to improve the return on equity (ROE) of publicly listed companies, addressing issues such 
as the high proportion of firms with price-to-book ratios (PBR) below 1x, which often signals poor capital management.

In summary, wage hikes signal the potential start of a positive economic transformation in Japan, benefiting consumers through increased purchasing power and enabling globally active companies to thrive both domestically and internationally.

Would you please comment on significant portfolio changes in 2Q?

In the second quarter, we have initiated new positions in three major Japanese homebuilders: Sekisui House, Ltd., Sumitomo Forestry Co., Ltd., and Daiwa House Industry Co., Ltd. This reflects a deliberate shift towards capturing long-term growth opportunities outside of Japan, particularly in the expanding U.S. single-family housing market. We believe that these companies stand out due to their innovative construction methods, quality focus, and growing footprint in the U.S., where they are among the few foreign players actively competing.

Despite short-term challenges in the U.S. housing sector such as rising mortgage rates and construction costs, the fundamental supply-demand imbalance and favorable demographic trends create a compelling investment case. Moreover, this addition diversifies the portfolio further into the homebuilding sector, complementing existing holdings in financials and other sectors, while offering attractive valuations and dividend yields that provide a margin of safety. Overall, this change signals a more international and growth-oriented tilt in the portfolio, balancing relatively stable domestic earnings with exposure to potentially promising overseas markets.

How do valuations in Japan compare to the U.S. and Europe?

Valuations in Japan appear more reasonable and grounded compared to the U.S. and Europe, especially when viewed over the long term. Since the end of 1989, Japan’s stock market has significantly lagged behind the U.S. and European markets. Unlike the frothy market of 1989 with inflated valuations unsupported by corporate earnings, today’s Japanese market, as measured by the Tokyo Price Index (TOPIX), trades at a more modest forward P/E of around 15-16x, reflecting stronger corporate profitability among large-cap companies.

While Japan remains a significant laggard in cumulative market returns compared to the U.S. and Europe, its valuation metrics are currently reasonable and attractive given the quality and profitability of Japanese companies. The Fund trades at a lower price-to-earnings ratio than TOPIX despite higher return on equity, reflecting potential undervaluation relative to fundamentals. This valuation gap is even more compelling considering many portfolio companies report cash-based earnings higher than accounting profits. Compared to the U.S. and Europe, we believe Japan’s market offers an opportunity for investors seeking high-quality global companies at more reasonable multiples, especially amid geopolitical shifts and evolving trade policies.

What is your outlook for the remainder of the year?

For the remainder of 2025, we expect a cautiously optimistic environment for Japanese equities:

Tariffs and trade policies will remain a key watchpoint. While U.S. tariffs have introduced uncertainties, we believe that their rationale as part of a broader strategy for fiscal discipline, economic growth, and national security suggests a medium-to-long-term benefit, especially for Japanese firms with global reach. The move toward reciprocal tariffs could ease tensions over time.

Fiscal deficits and government debt concerns in the U.S. pose risks that could influence global interest rates and economic growth. However, the Trump administration’s efforts toward deregulation, government efficiency (e.g., DOGE initiative), and private-sector-led growth may help stabilize the outlook. The Fund’s positioning in what we believe to be high-quality Japanese companies with strong earnings and resilient business models offers potential downside protection against short-term market volatility, which is likely to persist given global economic uncertainties.

Valuations of Japanese equities have become more attractive relative to earnings quality, presenting potential buying opportunities amid intermittent sell-offs driven by hedge funds and short-term traders.

Currency fluctuations and potential global economic slowdowns remain risks to monitor, but we remain confident in the long-term growth prospects of Japanese global companies within the portfolio.

 

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