We are excited and bullish about the opportunity set in Japan both from an equity and multi-asset, risk-adjusted perspective.
For example, we think Japanese rates and FX markets have reached levels where macro and micro trades can generate strong alpha.
Macro conditions surrounding the country indicate the economy is in a transition period from expansion to modest growth, which will continue to affect asset valuations.
Structurally, we think it is one of the few markets that enables managers to exploit market inefficiencies across asset classes.
We see these alpha generation characteristics arising from the depth of the market, a relative lack of investor crowding, strong cultural barriers and/or truly idiosyncratic events.
In 2018, market conditions were particularly challenging for some of the managers we favour and have invested with, especially those focused on fundamental research with a longer term investment horizon.
Extraordinary conditions distorted the ability of such managers to stay with conviction ideas and hedge portfolios effectively. We think this type of market regime will continue into 2019, albeit in a more moderate form than 2018.
On the bear side, if we look at equity strategies, the rotation between and the net sell-off from some sectors should keep accelerating.
The abundant capital flows from international investors into Japan assets that we saw since 2012, which drove valuations higher, began to retreat considerably in 2018.
Sectors with a high exposure to trade with China and US will suffer, to the point that Q1 should start reflecting the repricing of those that were historically winning stocks.
On the bull side, active trading with low risk and low leverage will be a strong beneficiary in 2019. A defensive positioning coupled with strong research capabilities should result in a focus on compelling ideas.
Pablo Urreta is head of research at Sussex Partners
• Japanese equity markets remain inefficient and under-researched compared to other developed markets, creating opportunities for active managers
• Active trading with low risk and low leverage will be a strong beneficiary in 2019. A defensive positioning coupled with strong research capabilities should be of benefit
• Fundamental value investing can be challenging due to the twin warping influences of massive quantitative easing from the Bank of Japan and foreign asset flows
• A continuation of the sector rotation we have seen in 2018 would act as a further challenge, requiring careful monitoring of sector exposures to avoid being caught on the wrong side of any further move