For those of us of a certain vintage, you’ll remember the 1980s as the decade where Japan was going to take over the world. Japanese firms were buying up iconic American assets from Rockefeller Center to Pebble Beach. Business schools were teaching Japanese management techniques and the Nikkei 225 index hit an all-time high of 38,916 on the last trading day of 1989. Then came the bust. For 30 years, Japan became the cautionary tale of what happens when asset bubbles burst. Deflation became entrenched, wages stagnated, and investors largely forgot about the Land of the Rising Sun.
Fast forward to today, and something remarkable is happening. Following several days of due diligence in Tokyo last month, meeting with everyone from the Japan Exchange Group (which operates the Tokyo Stock Exchange) to major private equity firms and corporate executives, our conviction in the Japan thesis has strengthened considerably. As the CEO of JPX put it, the market may only be in the “top of the second inning.” For a country that knows a thing or two about baseball (thanks to legends like Shohei Ohtani), that’s quite the setup for the innings ahead.
Sayonara to Deflation
Here’s the thing about deflation that’s hard for us in the West to fully appreciate: when prices fall year after year, cash becomes king. Why invest today when your money will buy more tomorrow? Why ask for a raise when prices are declining anyway? This deflationary mindset became deeply embedded in Japanese corporate and consumer behaviour for three decades.
The Bank of Japan is now cautiously raising rates for the first time in decades, with expectations of reaching 0.75% by early 2026 and potentially 1% later in the year. While that may seem laughably low by our standards, remember that Japan is emerging from an era of near-zero and even negative rates. Headline inflation is holding around 3%, with pockets like construction running significantly hotter. Developers on the ground told us real-world construction cost increases are closer to 10% annually due to labour scarcity, material costs, and the weak yen.
And here’s the kicker: while the West fears inflation, Japan welcomes it. Inflation is seen as a necessary catalyst for productivity and earnings growth. It’s a complete inversion of the mindset we’ve been living with for the past few years.
Corporate Governance: This Time It’s Different
I know, I know. “This time is different” are the four most dangerous words in investing. But hear me out.
Japan’s governance evolution has been underway for decades, but the pace of change has accelerated meaningfully. The Tokyo Stock Exchange has adopted a clever “name and shame” strategy, publishing lists of companies with good disclosure practices alongside anonymous examples of poor performers. It’s a very Japanese approach: transparency with discretion, encouraging compliance without causing excessive loss of face. The result? Approximately 72% of Prime Market companies now meet governance disclosure expectations.
Cross-shareholdings, those cozy arrangements where companies hold shares in each other to prevent hostile takeovers and maintain the status quo, have fallen dramatically. From roughly 55% in the 1980s, they’ve declined to 11.2% in 2024 and are expected to drop further. That’s roughly 60 billion USD in holdings unwound in the past year alone. Companies are proactively addressing these issues to avoid activist intervention.
Perhaps most remarkably, domestic institutional investors are no longer rubber-stamping leadership decisions. This is considered an “extraordinary development” that was unheard of 5 or 10 years ago. Japanese pension funds and asset managers are starting to prioritize returns over long-held loyalties.
The Labour Market Revolution
One of the most striking changes is the erosion of lifetime employment, that uniquely Japanese institution where workers joined a company out of university and stayed until retirement. Labour mobility has reached its highest level in decades as workers switch jobs for higher pay and better conditions.
Companies now face intense competition for engineering and technical talent, with China and Taiwan actively recruiting Japanese workers. This is forcing Japanese firms to raise wages, modernise workplaces, and accelerate investment in automation and digital tools. For the first time in a generation, Japanese workers have real bargaining power.
Private Equity: The Strongest Pipeline in 25 Years
One large alternative investment firm described the current opportunity set in Japan as the strongest in 25 years.
What’s driving this? Conglomerates under pressure to improve return on equity are divesting non-core subsidiaries. The surge in corporate carve-outs, succession-driven divestitures, and take-private transactions provides a robust pipeline for private equity managers. More CEOs than ever are considering taking companies private, following US trends. Being a public company was historically seen as prestigious in Japan, but many now find that private ownership allows them to be more strategic and focus on longer-term growth.
Real Estate: Rents Rising for the First Time in Decades
Tokyo’s 23 wards have seen residential and commercial rents rise about 10% year over year. Landlords now have pricing power, even in sectors where tenants historically held the advantage. This is a meaningful shift in a market that had been characterized by stagnant or declining rents for a generation.
What makes Japanese real estate particularly interesting today is the durable positive spread between borrowing costs (about 1.5 to 1.8%) and cap rates (3 to 5%). This positive rate gap is rare among developed markets and has helped keep cap rates stable even as interest rate expectations rise. Add in construction cost increases of roughly 50% over five years and supply constraints expected from 2027 onward, and you have an attractive backdrop for long-term investors.
Investment Implications
Japan’s structural transition creates a favourable environment for active investors. Our existing positions with managers focused on governance-driven change, balance sheet optimisation, and improving capital discipline are well aligned with these shifts.
Beyond public equities, allocating to select private equity partners with deep local networks may allow us to capture value creation before improvements are reflected in public markets. Real estate deserves equal consideration given rising replacement costs, sustained rental growth, and the persistent positive spread between borrowing costs and asset yields.
Japan offers a multi-dimensional opportunity across public equities, private equity, and real assets. Many companies still trade near or below book value, providing downside protection while offering upside potential tied to the end of deflation and improved capital efficiency. It’s a compelling mix that’s increasingly hard to find in today’s markets.
As we like to say around here, the best investments often come when you’re buying into a narrative that others have given up on. For 30 years, Japan was the market that investors forgot. Perhaps it’s time to remember.
For those interested in reading more about our thoughts on Japan, please reach out.
Sayonara until next time.
