The Case for Japanese Equities

Over the past decade, Japan has evolved from a value trap to a more compelling long-term equity opportunity. This shift is being driven by policy initiatives and structural reforms in corporate governance that directly target capital efficiency, liquidity and shareholder value.  As a result, the return on capital of Japanese stocks has converged with developed markets while the total shareholder payout ratio has increased. There is room for continued improvements while valuations remain attractive relative to global equity markets.

Notable policy initiatives include the following:

• In 2023, the Tokyo Stock Exchange (TSE) announced plans to accelerate previous reforms, requesting that listed companies implement “management that is conscious of the cost of capital and stock price” through strategies that improve profitability, raise valuation metrics and earn investor confidence. The TSE outlined expectations for policies to improve specific profitability and market valuation targets in a form easy for investors to understand. Noting that a P/B (price-to-book) ratio below 1 indicates company profitability does not exceed its cost of capital or that “investors are not seeing enough growth potential” while even if the P/B ratio is above 1, companies should target further improvement. Companies that did not comply faced delisting or being moved to a lower section of the exchange.
• The Japan Exchange Group (JPX) is revising the TOPIX (October 2026 launch date) to improve liquidity (value of shares trading), broaden coverage and to make it a more investible representation of Japanese equity market. This includes setting new selection criteria that requires companies to increase the number of free-float shares (excluding cross-holdings) to remain in the TOPIX.

These policy goals incentivize companies to shed non-core holdings (cross-ownership shares and real estate) and cash to repurchase shares or issue dividends. As a result, total shareholder payout ratio has risen with Japanese companies setting an all-time high in buybacks in 2023–2024.

There has also been notable improvement in board/management/shareholder alignment with an increase in stock-based compensation from under 500 companies in 2013 to over 2,500 in 2025 and increasingly independent boards.

This has translated into solid performance for Japanese equities, outperforming the S&P 500 YTD through 10/31/2025 with the lowest P/B ratio SMID-cap stocks the best performing segment since the TSE announcement in March 2023. Importantly, there appears to be room for continued progress and upside for Japanese stocks over the next few years.

• Valuations have risen. Forward P/E ratio is above the 20-year average, but Japanese equities remain relatively attractive compared to US markets.
• The improvement in company fundamentals since the early 1990s, largely encompassing the economic stagnation of the Lost Decades, has been nothing short of historic; on par with economies emerging from deep recessions or developing markets undergoing structural upgrades. Return on equity has more than doubled and is now around 10%. While more competitive, it remains well below other global markets. In addition, asset turnover remains well below developed market peers, suggesting the reform cycle is still in its early stages and that fundamentals have further room to improve.

• The shift from deflation to inflation stands to reshape companies, consumers, and the broader economy. Lazard forecasts Japanese earnings growth to increase from 2% to 13%, on par with the US and EM, in 2026. Households, in response to inflation, are reallocating their assets away from non-interest-bearing assets like currency and deposits toward riskier options like equities.
• Japanese regulators seem focused on the largest stocks trading below a 1x P/B target ratio. The number of stocks trading below a 1x P/B ratio has declined; within the TOPIX from 43% in July 2022 to 28% from). However, within the TOPIX, 580 of 1,670 stocks still trade below a 1x P/B ratio with market capitalizations < $4B.
• The divestiture of non-core assets and return of capital shareholders through buybacks and/or dividends is expected to continue, supported by increasing activism. 2025 has seen a record number of activist proposals and M&A activity as private equity becomes more active.

This potential is reflected in GMO’s 7-year real return forecasts, led by USD returns to Japanese small-cap value stocks.

Corporate governance and regulatory reforms are actively unlocking Japanese equity value. For long- term investors, there is a case for a dedicated Japanese equity allocation as part of a fully invested, globally diversified portfolio. There are several ways, varying by strategy, liquidity and cost, to gain exposure to Japanese equities, including:

• A passive ETF providing liquid, lower cost exposure to smaller-cap companies with high dividend-paying or buyback stocks.
• An active mutual fund with a fundamental, long-term, value-oriented approach focused on SMID-cap stocks.
•  A hedge fund providing targeted exposure to SMID-cap companies with P/B ratios <1x offering monthly redemptions with 30-day notice and no lock or gate.

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