Nikkei price index lost up to 80 percent
Japan, what was it like again? Those of you who are a little older will still remember the years up until 1990, when the country was a dream for investors from all over the world. Property prices in Tokyo soared and stock prices also went completely out of control. “Anyone who pointed out the grotesque overvaluation at that time was not listened to anywhere. Everyone thought it would last forever,” recalls the scientific head of our investment team, Stephan Kühnlenz, who at the time worked as a researcher for a renowned financial institution.
The subsequent decline was even more painful. The best-known Japanese stock index, the Nikkei 225, fell by 77% in euro terms. If we exclude dividends, i.e. only look at the price index without dividends, the Nikkei is currently (as of July 3, 2024) still below its 1989 peak.
Nikkei Return Index Has Performed Similar to MSCI World for a Long Time
However, investors now receive dividends even if they invest in a fund or ETF based on the Nikkei price index. This means that the performance of Japanese stocks over the past decades does not look so dismal. As the following chart shows, the performance of the Nikkei 225, including dividends, has run almost parallel to the MSCI World stock index for a surprisingly long period. After all, it is Japanese stock market also the second largest after the US. What is striking is the growing gap in performance since 2021, that is, since interest rates in the euro area rose sharply compared to interest rates in Japan.
Notes on the graph:
- In the graph we present both indices from the perspective of a European investor.
- Unfortunately, there is no time series for the years prior to 2002 that shows the evolution of the Nikkei including dividends.
Japanese stocks performed well – from a Japanese perspective
So from the perspective of euro investors, does the Nikkei’s worse performance against the MSCI World since 2021 mean that the Japanese stock market has performed worse? No, measured in local currency terms, the main Japanese index has performed better than the MSCI World since 2021. The Japanese economy is doing well, with export-oriented companies in particular doing well due to the chronic weakness of the Japanese currency.
And the Japanese stock market does not yet appear to be overheated if we look at the so-called price-to-earnings ratio (P/E ratio). Currently, as of June 30, 2024, the P/E ratio of listed Japanese companies is 17, slightly above the long-term average of 16. For comparison: MSCI World currently has a P/E ratio of 22 compared to a median P/E ratio of 19.
Euro at all-time high against Japanese yen
However, euro investors will not be entirely satisfied. In their view, the performance of Japanese equity funds has been reduced by the strong appreciation of the euro against the Japanese yen, as the chart below shows. What is good for holidaymakers in Japan and for Japanese people with assets abroad is reversed here. Since the euro was introduced in 1999, the euro has never been so expensive compared to the yen (as of 3 July 2024). The Japanese central bank has repeatedly tried to slow the decline of its national currency through support purchases, but has so far been unsuccessful.
The coverage recently paid off
Anyone looking to invest extensively in the Japanese stock market can choose between two options: without or with exchange rate coverage (“hedged”). Many Japanese funds also have tranches that at least mitigate the currency risk between the euro and the Japanese yen. And anyone who had invested in such a hedged fund over the past three years would have performed better than in the unhedged variant, as the following chart shows.
In the most recent period, since 2021, the currency-hedged variant has clearly outperformed the unhedged variant. The worse performance of the unhedged index is due to the depreciation of the yen against the euro, as described above. And this depreciation, in turn, is due to the fact that interest rates in the Eurozone have risen significantly compared to interest rates in Japan.
However, the chart also makes it clear that currency hedging does not guarantee superior long-term performance. In a long-term comparison, sometimes the unhedged variant and sometimes the currency-hedged variant come out ahead.
Note on the graph:
- The chart does not show the Nikkei index, but rather the Topix index. Both represent the Japanese stock market, but the Topix is size-weighted, like the MSCI Japan, and therefore in our view a better benchmark than the price-weighted Nikkei. More on Japan’s various indices below.
Uncertain bet on monetary evolution
Basically, we do not attach much importance to currency hedging in fund investments. For broadly diversified global equity funds, it is unnecessary or even counterproductive because hedging is not free. Hedged funds have slightly higher annual costs than unhedged funds tracking the same index. In the case of special country funds, with Japan as a prime example, currency hedging can make sense – if a favorable phase is achieved. The question is whether this is still the case with the euro at an all-time high compared to the yen. By investing in a hedged ETF, investors are betting that the current trend will continue. If the trend were to reverse, i.e. if the yen were to rise against the euro, the bet would have failed. Then two disadvantages could even come together: a fall in share prices due to the decline in the export advantage of Japanese companies and a loss of profits due to the rise of the yen.
With or without currency hedging?
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Nikkei is not the first choice
Everyone has to make the decision for themselves whether to engage in currency hedging. Our fund rating will help you answer the question of which Japan index you should choose. We forgive the judgment First choice only for ETFs based on indices that broadly reflect the respective market. This means that they have to weight the stocks according to size, i.e. their market capitalization. In the case of Japan, these are the MSCI Japan, Solactive Japan and Topix, partly also in the form of sustainability indices for ethically and ecologically oriented people. In our opinion, the aforementioned Nikkei 225 is not suitable as a basic investment for the Japanese stock market because it is a price-weighted index.
As the chart below shows, the Nikkei 225 was not a bad investment. Over the period shown, it outperformed the Topix and MSCI Japan market variants.
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