Japan's quiet outperformance: why investors are taking notice

Ask any investor where the best stock market returns have been achieved in recent years and they will almost certainly mention the US. Most likely they will talk about tech stocks and the Magnificent Seven. The more engaged might give a nod to India. More recently they are likely to have noticed the fireworks in Korea.

The market they are very unlikely to place at the top of the leaderboard is Japan. Forty years on from the Japanese stock market and property boom, Asia’s most developed market still struggles to shake off its reputation as a deflationary demographic disaster. It is the market I have always struggled to interest our investors in. Which is a shame. Because over the past decade and a half, it has been a fantastic performer.

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If you had invested £100 in the FTSE 100 in the summer of 2012, you would have around £180 today. Not terrible, but an unexciting annualised return. By contrast, the same £100 invested in the US over that 14-year period would be worth £531, nearly three times as much. No surprise there. The post-financial crisis recovery years were dominated by big, successful US tech stocks. What might surprise you, however, is that £100 invested in Tokyo over the same period is today worth £532. By the narrowest of margins, Japan has pipped the US to the post.

Japan has quietly been the best performing slice of my pension, un-flashily delivering the goods year after year. I think it will continue to do so. For a variety of reasons, the stars are well aligned for Japan. And I am no longer in a small minority of eccentric Japanophiles. The broader investment community is cottoning on.

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Part of the case for Japan has been well rehearsed. The escape from 30 years of deflation - in which GDP barely grew, wages stagnated, and companies sat on their cash in the absence of anything better to do with it - are now firmly in the rear-view mirror. Now the country is benefiting from a healthy level of inflation, around the Bank of Japan’s target, positive wage growth, and consequently improving domestic demand.

A second tailwind that is well understood is the positive impact of corporate reforms. Encouraged by the government and Tokyo Stock Exchange, the country’s leading companies have implemented these with surprising alacrity. Better governance is showing up in the unwinding of complex cross-shareholdings, more mergers and acquisitions, and notably in growing levels of share buybacks and dividends. 70% of companies are raising their payouts to shareholders, a new record.

What is new, with the potential to keep the Japanese market bubbling, is the country’s exposure to the world’s big capital expenditure themes. Japan is the ultimate picks and shovels play, not just on AI, but on reindustrialisation, reshoring, automation and higher defence spending. In a new boring-is-good world in which capital-light Silicon Valley hands on the baton to a power-hungry ‘real stuff’ economy, Japan offers investors a broad-based, high-quality, diversified, sensibly priced opportunity. Unlike Korea, it is not a two-horse race.

Japan has deep experience and expertise in many of the sectors that will underpin the AI revolution and the broader pendulum-swing back to a hard assets economy: factory automation, precision machinery, power equipment, defence electronics, industrial materials, telecoms networks and construction. Names that you will have heard of: Kawasaki, Mitsubishi, NTT. Others that you may not have: Keyence, Softbank, Fanuc.

The top-performing sectors so far in 2026 have been metals, electrical appliances and precision machinery, plays on AI investment via optical fibre for data centres and memory chips. Machine tool orders are at a record high, driven by demand from both the US and China.

But the winners are broader than this. The third best performing sector is banks, a play on domestic reflation and higher interest rates, with another quarter point hike looking likely next week. The sustainability of returns is reflected in the more subdued returns year to date of the broad-based Topix index, compared to the narrower, tech-exposed Nikkei 225 index.

Japan has a long history of disappointing overseas investors. A colleague of mine used to joke that it is never too late to short Japan. He was wrong but, even now, overseas investors have less invested in Japan than you would expect, given its weight in the global indices. Slowly but surely, that is changing. Having dipped in and out of Japan, treating it as a tactical trade, longer-term investors are now seeking a permanent exposure to the country’s shares.

Domestic investors, too, are learning to love their home-grown investments, with about half of investments in the Japanese equivalent of our ISA now represented by local shares. Around a fifth of household assets are invested in equities, a notable shift from the traditional Japanese preference for bank deposits and government bonds.

It is still easy to find reasons to be sceptical about Japan. The country’s ageing population is in long-term decline; it has the highest level of government debt in the developed world; its exports are vulnerable to a strengthening in the yen. But Japan is slowly becoming a normal developed economy again, with rational levels of inflation, interest rates and bond yields.

Above all, Japan is well-placed for a resurgent bricks and mortar world in which wealth creation reverts to the manufacture of high-quality real stuff that you can touch. No-one does that as consistently well as the Japanese.

For investors who want actively managed exposure to this opportunity, Lazard Japanese Strategic Equity has recently been added to Fidelity’s Select 50 list of handpicked funds. The fund takes a high-conviction approach to Japanese large and mid-cap companies, seeking out mispriced opportunities.

• Read: Lazard Japanese Strategic Equity: new to Select 50

This article was originally published in The Telegraph.

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Select 50 is not a personal recommendation to buy or sell a fund. Overseas investments will be affected by movements in currency exchange rates. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.