Why domestic plays in Japan look appealing

The Trump administration’s intent to negotiate tariff policy with Japan has led to an uncertain business outlook for many of the nation’s exporters, so Fidelity Portfolio Manager Kirk Neureiter has turned to domestic-oriented Japanese firms seen as newly appealing amid these dynamics and recent corporate governance reform.

“To my way of thinking, there are two potential advantages to investing in firms primarily driven by Japan’s domestic economy,” says Neureiter, who manages Fidelity® Japan Fund (FJPNX). “First, you may be able to sidestep much of the fallout from the current battle over tariffs. And second, you could stand to benefit from the improved corporate governance of many lesser-known Japanese companies.”

In helming the focused Japanese equity strategy, Neureiter seeks businesses that are attractively priced relative to the market and that have benefited from new market development, evolving capital structures, efficiency improvements, pricing power or a change in management incentives.

In April, the Trump administration announced a steep hike in tariffs on most goods imported into the U.S., notes Neureiter, adding that Japan has a significant trade surplus with the U.S. It is a major exporter of autos, steel, machinery, semiconductors and advanced materials, as well as a key ally for the U.S. in the Asia-Pacific region, according to the portfolio manager.

Regarding corporate governance, Neureiter explains that in 2015 the administration of former Japan Prime Minister Shinzo Abe oversaw the creation of stewardship and governance codes for all listed corporations. Specific concerns included the entrenched nature of existing management teams; excess retained earnings; too many non-core, low-return assets; and conservative decision-making. Then, in 2023, the Tokyo Stock Exchange restructured its listing categories to reward quality.

“These developments have resulted in steady improvement in the decision-making of Japanese management teams – especially in the mid- and small-cap market segments,” says Neureiter.

One domestic story worth following is Japan’s defense industry, he says. Here, Neureiter has favored three companies: IHI, Mitsubishi Heavy Industries and Kawasaki Heavy Industries. Japan, which since World War II has included specific language in its constitution renouncing war, has recently shifted its spending priorities and is now engaged in building its defense capabilities, which Neureiter believes could benefit this trio of defense contractors.

Elsewhere in the portfolio, Sumitomo Mitsui Financial Group remained a significant holding as of August 31. Among Japan’s major banks, Sumitomo is most levered to the domestic economy, with the highest share of the small and medium enterprise market, says Neureiter. Additionally, he believes the company could see positive effects from rising interest rates in Japan, along with the possibility of dividend increases and stock buybacks.

“Given these catalysts, I’m optimistic about the earnings potential for each of these domestically focused companies,” concludes Neureiter. “Although trade and tariffs have been garnering a lot of headlines lately, the main story in Japan continues to be improved corporate governance, with all the perceived benefits that implies for stockholders.”

Specifically, he cites higher dividends and share repurchases, as well as more capital being spent on plants, equipment and other productive uses, instead of keeping excess cash on the balance sheet or spending it on cross-shareholdings.

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