Equity Factors In Japan

Land of the Rising Alpha?

August 2017. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • Japan has unique characteristics from an economic perspective
  • Factor performance in Japan mirrors global factor performance
  • Debt & demographics seem to matter less than underlying factor drivers

INTRODUCTION

Japan is an unusual country from many perspectives – it has only close neighbours to the West of its coastline, was isolated for centuries, developed a unique culture and cuisine, and has had a shrinking population for a few years. The poor demographics led to low economic growth, too much debt, and extreme policies by its central bank, which is reflected in equity markets that have gone nowhere in the last 25 years. Unfortunately, the US and Europe now share some of these characteristics, i.e. declining populations (Europe) and record levels of debt (Europe & US). It’s therefore interesting to analyse the factor performance in Japan and consider implications for factor performance of markets that have become more similar to Japan, which we will do in this short research note.

METHODOLOGY

We’re going to analyse the five most well-known factors: Value, Size, Momentum, Quality, and Growth. Factor data is available since 2000 for Japan and Global ex-Japan, which is a combination of developed markets in the US, Europe, and Asia and weighted by the number of companies available in the stock universes. It’s worth highlighting that the weight of the US is approximately 61%. The factors are constructed as long-short portfolios by taking the top and bottom 10% of the stock universes in the US, Europe, and Japan while taking the 20% in other markets as there are less stocks available. Only companies with a minimum market capitalization of $1bn are considered and 10bps of transaction costs are included.

CORRELATIONS: JAPAN & GLOBAL EX-JAPAN

The chart below shows the daily correlations between the factors Japan and Global ex-Japan. We can observe low correlations across factors, which implies diversification benefits from combining factor exposure of different countries. An investor seeking exposure to the Value factor might notice the low correlation of Value Japan to Value Global ex-Japan of 0.15 and seek to combine these as theoretically they should generate returns independent of each other.