Alpha-generating opportunities surge in Japan, as economic recovery and market reforms gather pace

Japan’s macroeconomic backdrop is strengthening alpha-generating opportunities for hedge funds, with a growing number of newly-launched Japanese equity strategies looking to capitalise on a kaleidoscopic range of stockpicking ideas arising from market-friendly structural reforms, a pick-up in economic momentum, improving fundamentals, and a falling number of coronavirus cases.

Japan’s macroeconomic backdrop is strengthening alpha-generating opportunities for hedge funds, with a growing number of newly-launched Japanese equity strategies looking to capitalise on a kaleidoscopic range of stockpicking ideas arising from market-friendly structural reforms, a pick-up in economic momentum, improving fundamentals, and a falling number of coronavirus cases.

Strategists at Lyxor Asset Management said on Friday the prevailing market landscape appears supportive for risk assets and stronger economic growth heading into Q2, with a second Covid-19 wave now appearing past its peak and its impact so far appearing largely manageable.

“With the pandemic gradually abating and as the Japanese economy regains some momentum, we see a wider set of investment themes, supporting stockpicking,” senior Lyxor strategists Jean-Baptiste Berthon and Philippe Ferreira, and EU head of hedge fund research Bernadette Busquere Arnal, said in a market commentary.

“These themes include stocks sensitive to domestic consumption, exposure to Asia, reflation policies or capex. The alpha environment has already improved.”

Against that backdrop, Lyxor strategists are “not surprised” by the surge new Japanese equity fund launches.

“Their returns are increasingly differentiated and reflect uneven positioning and uneven investment themes. They raised their overall exposure, expressing confidence,” Berthon, Ferreira and Arnal observed.

“While their alpha was impaired during the 2017-2019 trade war, it is now back in positive territories. All-on-all, making greater room for Japanese equity active managers in portfolios makes sense to us.”

Analysis reveals Japanese equities remain under-owned, with the trade war and coronavirus pandemic having driven down allocations to Japanese stocks by some 2 per cent of in world market capitalisation since 2018.  Japan is also leveraged to the global cycle – “highly sensitive to activity in Asia, China and the US”, Lyxor said – with its main exporting products also cyclical.

At the same time, the assortment of market-friendly structural changes under way – with Suganomics’ focus on decarbonisation, digitisation, sector productivity improvement, and higher mobile penetration – will help strengthen access for foreign investment, and further boost corporate activity.

All of which offers a rich alpha environment for hedge strategies, Lyxor’s research concluded.

“Dispersion across stocks, sectors, factors and themes – a gauge of managers’ arbitrage potential – remains elevated and consistent with diverging economic trends across sub-industries,” the strategists wrote.

“Correlations are steadily declining, emphasizing more diversified opportunities. Moreover, fundamental pricing – how stock prices reflect underlying companies’ fundamentals – is improving, another pivotal factor for alpha generation.”