Global investors are often underweight Asian equities. Japan is the second largest country in the MSCI World Index after the U.S., but many have yet to consider a long-term active investment strategy for Japan and some have no exposure at all to Japan.
Japan is the second largest developed market and fourth largest exporter globally, but its geographic location and economic ties with other Asian countries make it unique from western economies. We do not believe that Japanese equities are highly correlated with global or DM equities, and as such the asset class offers clear diversification benefits as well as being a unique source of alpha.
Empirically, Japan does not show meaningful diversification benefits at the market level. But style factors in Japan show low correlations with each other, as well as with style factors in other markets. This diversification at the style level allows for more flexibility in the asset allocation process in terms of factor exposure.
Although Japan is a highly institutionalized market, over the last decade active equity managers in Japan generated more excess returns and idiosyncratic alpha than those in the U.S. and Europe. This supports our belief that Japan offers a unique source of alpha, as companies lead a grassroots change with the support of the government after decades of economic challenges.